A:

The drugs sector is a good choice for value investing because it always has demand and a competitive moat. This simplifies one task for the value investor. Value investors typically load up when valuations are low and business conditions are weak, with the dominant emotion being fear. Typically, they are most active during recessions.

One drawback to value investing is sometimes companies become cheap because the market is anticipating diminished earnings going forward due to structural changes in the economy. These are known as value traps and can be quite deadly for value investors' returns. The economy is constantly changing with new industries emerging and old ones dying; one pitfall of value investing is dying industries can at times look like compelling, cheap opportunities. Therefore, value investors need to go beyond identifying cheap stocks or sectors by also finding moats that ensure continued relevance.

Drugs Sector

The drugs sector, as a whole, certainly has a competitive moat. It is hard to imagine a future in which the economy changes in a way that erases the need for the drug industry. Of course, it is certainly possible that individual companies within the drugs sector are not able to develop new treatments and end up as poor investments. Drug companies temporarily have a competitive moat when they have patent protection on their products and are able to sell them exclusively, earning windfall profits.

Valuing drug companies is inherently difficult due to the uncertainty of determining future cash flows. An investment in a pharmaceuticals company is a vote of confidence that its management continues to successfully develop new drugs and bring them to market. Another option for management is to buy smaller companies with promising drugs in development. The massive cost of bringing a drug to market and the institutional knowledge required is a strong competitive moat for drug companies.

Favorable Trends

Many potent trends add to the appeal of the drugs sector for value investors. These are secular trends that hold true regardless of economic conditions. One is advances in biotechnology, which have significantly reduced the cost of drug development. This has morphed the development process from one of expensive trial and error to using genomics to cut costs by 90% in many instances. Futurists discuss a day when all types of treatment are personalized based on a patient's DNA.

Two more trends that should continue to drive revenue and earnings growth for the drugs sector are the Affordable Care Act and aging populations all over the world. Implementing the Affordable Care Act has insured nearly 17 million people. This created more customers for the drugs sector. Demographics is another factor leading to increased demand for drugs as the world's population ages. Older people consume more drugs, especially people in developed nations where there is more wealth and generous government subsidies.

RELATED FAQS
  1. What are the primary factors that drive share prices in the drugs sector?

    Learn about the primary factors that drive share prices in the drug sector. Creating and manufacturing drugs is a complex ... Read Answer >>
  2. What is the drugs sector?

    Learn more about the drug industry and how new drugs are brought to market. Find out about how drug research is financed ... Read Answer >>
  3. How does government regulation impact the drugs sector?

    Learn about how drugs are regulated by the U.S. government as well as the role of the Food and Drug Administration during ... Read Answer >>
  4. Is the drugs sector better suited for active or passive investment?

    Learn how passive investing can make a person good money in the drugs sector, but shrewd active investing can make a person ... Read Answer >>
  5. What level of return on equity is average for a company in the drugs sector?

    Find out more about the drugs sector, which industries are included in the sector and the average return on equity for companies ... Read Answer >>
  6. What process does a company need to follow to bring a new drug to market?

    Learn about the costly price of bringing new drugs to market. Discover why the pharmaceutical industry invests billions of ... Read Answer >>
Related Articles
  1. Investing

    Using DCF In Biotech Valuation

    Valuing firms in this sector can seem like a black art, but there is a systematic way to pin a price on potential.
  2. Insurance

    Why Do Prescription Drugs Cost So Much?

    In 1975, it cost about $100 million in 2005 dollars to develop one drug from the lab to FDA approval. By 2005, that figure was $1.3 billion.
  3. Insights

    The Industry Handbook: Pharma Industry

    Learn about the pharmaceutical industry and discover the forces that influence this highly profitable and dynamic sector.
  4. Investing

    3 of America's Most Expensive Drugs and Who Profits From Them

    Learn about orphan drugs that are some of the most expensive drugs in America. Read about the companies that manufacture these drugs.
  5. Investing

    Cost of Old Cancer Drugs Rises in EU Amid Outcry

    The prices of several off-patent cancer drugs have soared more than 100% in Europe.
  6. Investing

    Drug Giants May Benefit From China Drug Inclusion

    Pharma giants may see higher sales as the Chinese government subsidizes expensive prescription drugs.
  7. Investing

    Drug Approvals Fell to Six-Year Low in 2016

    New drug approvals dropped to modest levels in 2016 following highs in 2014 and 2015.
  8. Retirement

    How to Pick the Best Medicare Part D Plan for You

    In choosing a Medicare Part D plan, here’s a helpful step-by-step guide to what you need to know to get the drugs you need at the price you can afford.
  9. Investing

    Drug Industry Launches TV Ads to Repair Image

    Lobbyists have rolled out TV ads to repair the drug industry's damaged public image.
  10. Investing

    Drug Supply Chain May Be Driver of High Drug Prices

    Non-manufacturing stakeholders in the drug pricing system are the ones contributing to high prices.
RELATED TERMS
  1. New Drug

    A new medication or therapy that has not been used before in ...
  2. Orphan Drug Credit

    A federal tax credit that provides an incentive for pharmaceutical ...
  3. Abbreviated New Drug Application (ANDA)

    A written request to the U.S. Food and Drug Administration to ...
  4. Orange Book

    A list of drugs that the U.S. Food and Drug Administration has ...
  5. Economic Moat

    The competitive advantage that one company has over other companies ...
  6. Phase 2

    The second phase of clinical trials or studies for an experimental ...
Hot Definitions
  1. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange.
  2. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  3. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability ...
  4. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  5. Whole Life Insurance Policy

    A life insurance contract with level premiums that has both an insurance and an investment component. The insurance component ...
  6. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
Trading Center