How to Buy Pharma Stocks

The pharmaceutical industry is attracting interest from both investors and consumers who are focused on the possibility of a vaccine amid the impact of the pandemic.

“Currently, there is a focus on COVID-19 vaccine candidates, so discussions on approvals including effectiveness, safety, distribution strategy and adoption are important,” says Jodie Gunzberg, managing director, chief institutional investment strategist at Morgan Stanley Wealth Management.

The number of drugs in a pharmaceutical company’s pipeline is crucial since the testing and U.S. Food and Drug Administration approval process can take 10 to 15 years, says K.C. Ma, a finance professor at the University of West Florida in Pensacola. After a drug is approved by the FDA, some companies will apply for a patent for the drug, which could grant exclusivity rights to produce the drug typically for about 20 years, he says.

[See: Best Biotech ETFs to Buy]

“Investors often look at the inventory of drugs with the number of remaining years of patent protection,” Ma says. “When the patent protection for the drug expires, the owner of the branded drug will introduce a generic version in order to get a head start in the generic market.”

Drug sales in the U.S. account for over a third of the global pharmaceutical market. Pfizer’s (ticker: PFE) cholesterol drug Lipitor was the best-selling drug — it averaged $13 billion annually and netted $141 billion total over its lifetime before Pfizer’s patent expired in November 2011.

Investing in the pharmaceutical industry can be challenging since it’s complex and includes biotechnology, life science tools and services, and veterinary drugs. If you’re interesting in pharma, keep these points in mind:

— How pharma and biotech stocks differ.

— Why pharma stocks can be more volatile.

— How to invest in pharma stocks and funds.

How Pharma and Biotech Stocks Differ

Investors should focus on the key distinctions between pharma and biotech names.

Pharma companies tend to be larger, more diversified and focus on manufacturing and distribution in addition to the development of drugs, says Mike Loewengart, managing director, investment strategy at E-Trade, an Arlington, Virginia-based brokerage.

Biotech firms are typically smaller, with a narrow focus on development within a niche. They can be a bit riskier and trade largely based on trial data, he says.

The burgeoning psychedelic sector has drawn interest from investors since more companies are now public, including MindMed (MMEDF) and Compass Pathways ( CMPS). There are dozens of pharmaceutical companies in competition to develop intellectual property to synthesize molecules and rewire patients’ brains.

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MindMed, a Toronto-based neuropharmaceutical company, is working on a non-hallucinogenic molecule based on the psychedelic ibogaine to treat opioid addiction. The company is conducting a phase 2 trial to examine if LSD can treat cluster headaches and another phase 2a trial for LSD microdosing to treat adult ADHD. MindMed said it will start a phase 1 clinical trial with MDMA and LSD in the fourth quarter in Basel, Switzerland. Meanwhile, Compass Pathways is developing a synthetic version of psilocybin for treatment-resistant depression.

Public psychedelic companies have led to more appetite for private companies such as Toronto-based Cybin that is developing a dissolvable film with psilocybin to treat patients with depression or addiction. The company closed on a $45 million Canadian dollars financing round on Oct. 19, which is now Canada’s largest go-public financing round to date for a psychedelic company. The company plans to start conducting phase 2 trials in Jamaica by the end of 2020, says CEO Doug Drysdale.

Why Pharma Stocks Can Be More Volatile

Individual pharma stocks can be more volatile and are “often independent from the general market cycles and volatility,” Ma says. “The higher volatility is driven by each company’s idiosyncratic risk, research and development and the various patent and testing timetables.”

Drug companies that invest more in R&D and patents can experience more volatility, he says.

“(The) tricky part is in forming the assumptions since many highly variable pieces of information need to be incorporated like assessing the drug pipeline, patents and the competition,” Gunzberg says.

“Mid-cap and small-cap pharma companies may also be attractive acquisition targets, so identifying those can be lucrative, but it can also be difficult since projecting revenue is challenging from unknown pricing,” she adds.

While individual pharma stocks may be volatile, the industry is relatively stable when it’s compared with the S&P 500 or the S&P 500 Health Care, S&P 500 Biotechnology and S&P 500 Life Sciences Tools & Services industry indices, based on data from Sept. 30, 1992 to Sept. 30, 2020, Gunzberg says. The current annualized volatility of the S&P 500 Pharmaceuticals on a 36-month basis is 14.9% and on a 30-day basis is 18.3%. Currently, the S&P 500’s annualized 36-month volatility is 17.7% and annualized 30-day volatility is 23.4%.

Most of the industry’s relatively high volatility happened before 2003, but there was a period between June 2006 and June 2007 when the relative volatility climbed again, she says. Pharma’s relatively high volatility came in the periods ending in December 2019 to January 2020 before most of the pandemic lockdowns.

How to Invest In Pharma Stocks and Funds

Investors eyeing the pharma sector should be aware that there could be a “long road ahead potentially filled with twists and turns, especially when considering individual securities,” Loewengart says. Trials and timelines for FDA approvals can go off track, potentially leading to pullbacks in stock prices along the way, he says.

“Investors should look under the hood before investing and determine if the investment has legs beyond a single treatment,” Loewengart says. “That’s where mutual funds and (exchange-traded funds) can do some of the heavy lifting. Investing in a pharma-dominated fund can offer broad exposure to the sector and eliminate single-stock risk.”

The bottom line is that investing in pharma is not a sprint, it’s a marathon, he says.

[See: 8 Best Pharmaceutical Stocks to Buy for Income.]

Investors could consider adding either the iShares U.S. Pharmaceuticals ETF ( IHE) or the SPDR S&P Pharmaceuticals ETF ( XPH) to a portfolio, Ma says.

IHE tracks the Dow Jones U.S. Select Pharmaceuticals Index and the benchmark index includes pharmaceutical companies, such as manufacturers of prescription or over-the-counter drugs or vaccines, but excludes producers of vitamins. XPH tracks the performance of the S&P Pharmaceuticals Select Industry Index.

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