I just updated my main webpage to include a financial report of Johnson & Johnson so do check it out.
Also, its come to my attention that I didn’t update the Lubrizol Corporation link properly on the right hand side of the page. I have since corrected it.
Before investing in pharmaceutical companies, its important to know the pros and cons of the industry.
Big pharmaceutical companies typically have wide moats and attractive financial strength. Most of the global pharmaceutical companies post Returns on Invested Capital of > 20%. They also have little debt on their balance sheets and plenty of free cash flow generation.
However, developing drugs is extremely costly and time consuming. Clinical testing phases of drugs can take upwards of a decade. Whats worst is that these expenses does not guarantee the success of a drug. A company can pump in a considerable amount of money into research with no guarantee of return.
Once a drug is developed and approved by the FDA, they normally enjoy patent protection. This typically lasts about 8 – 10 years.
Armed with this knowledge, one should look for the following traits in pharmaceutical companies:
- Companies which have a diverse range of drugs, and that have considerable patent time left.
- Companies that are actively developing new drugs to refill their pipeline.
Due to their strong financial positions, many pharmaceutical companies are choosing to acquire smaller companies to replenish their pipeline. This really illustrates why free cash flow and low debt levels are so important. Companies that are highly leveraged and generate little free cash flow would be unable to fund such acquisition’s easily.
I am bullish on healthcare companies in the long run. As we face an aging population in developed nations around the world. Furthermore, as developing countries improve their standards of living, there will also be a corresponding increase in demand for better healthcare.
However, it’s important (to me anyway) not to get too carried away with macro trends. Always ensure that the companies you invest in are trade at a reasonable valuation no matter how rosy the outlook maybe.
The author is long JNJ.