Large pharmaceutical companies are generally considered good long-term investments. Companies like Pfizer, Johnson & Johnson, Roche and Merck are largely immune to damage from factors that drive the economy like recessions. They routinely pay dividends year after year. They can be safely held in a portfolio going into retirement. However, no investment is always secure. What are the risks of pharmaceutical stock investments? Some are common to all companies in this industry at all times and some are unique to today’s world.
Usual Risks of Pharmaceutical Company Investments
A company like Pfizer makes a lot of money when they have blockbuster drugs like they have today with their oncology product line. However, it can easily take five to fifteen years to develop an anti-cancer drug. A company invests a lot of money year after year before there is any economic payoff. The failure rate of anticancer drugs in clinical trials runs as high as 97% meaning that the company spends money with no eventual monetary reward.
High Costs of Developing Medicines
The process for making money by selling medicines starts with discovering a promising medicine. It needs to progress through testing to make sure that the drug is safe to give to humans and then that it is going to be effective in treating the condition or disease that it targets. The cost to develop an anti-cancer drug runs anywhere from $300 million per drug to $2.7 billion per drug according to a study published in the Journal of the American Medical Association. The study picked $648 million as the most accurate number overall.
How Much Profit Does a New Medicine Bring In?
When a new and effective medicine is developed, a pharmaceutical company can make huge profits. As an example, Merck’s Keytruda generated over 17 billion U.S. dollars in 2021 and nearly $21 billion in revenue in 2022. This happens when the drug meets a previously unmet need or performs far better than previously available medicines. There are many examples over the years of blockbuster drugs paying off for pharmaceutical companies. However, market dominance and blockbuster profits do not last.
How Long Are New Blockbuster Drugs Profitable?
Several factors influence how long a pharmaceutical company can make money on a new drug. New medicines can get patents if they are totally new and patents generally are good for 20 years. However, the patent starts when the drug is announced and goes into testing. It is quite possible that half the patent life or even more will be used up before the drug gets to market and starts generating income. When a new drug is discovered and research progresses other pharmaceutical companies learn how to create similar medicines and ones that often work better than the first one of a kind. Thus, a new blockbuster drug may be supplanted in sales by a competitor even before its patent protection runs out.
How Much Will Buyers Pay for a Drug?
Insurance companies and government agencies like the Veterans Administration effectively pay for many drugs because they either reimburse their clients or pay directly. These payers have the incentive to negotiate prices. They may choose to only OK competing medicines or treatments or find ways to refuse to cover a new drug. Thus, pharmaceutical companies are often forced into giving discounts to a large segment of their market. A new aspect of this issue has arisen with the Inflation Reduction Act pushed through Congress by the Biden Administration. Medicare now is able to negotiate drug prices with pharmaceutical companies.
According to the Department of Health and Human Services, drug price negotiation will soon begin. Here is a snapshot of how it will roll out.
By September 1, 2023, CMS will publish the first 10 Medicare Part D drugs selected for initial price applicability year 2026 under the Medicare Drug Price Negotiation Program.
The negotiated maximum fair prices for these drugs will be published by September 1, 2024 and prices will be in effect starting January 1, 2026.
In future years, CMS will select for negotiation up to 15 more Part D drugs for 2027, up to 15 more Part B or Part D drugs for 2028, and up to 20 more Part B or Part D drugs for each year after that, as outlined in the Inflation Reduction Act.
The point is that the most expensive drugs for the most people will be the first to be “negotiated” which effectively means they will be sold for less and become less profitable. We do not expect to see companies like Merck, Pfizer, Johnson & Johnson, and Roche to go out of business but we do expect to see a dent taken out of their profits going forward. How much this will affect share prices and dividends remains to be seen.
With all eyes on the US budget and increasing deficit we do not expect to see a lot of sympathy in Congress for rolling back Medicare drug price negotiations.
Risks of Pharmaceutical Stock Investments – SlideShare Version