Generic Drugs and Old People Could Make You Rich

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After tormenting investors for the past several years, CVS Caremark (NYSE: CVS  ) has been on a roll lately. Despite terrible returns, and its controversial and thus far unsuccessful attempt to combine the pharmacy benefit management business of Caremark with its retail pharmacy business, its stock has risen by more than a third since its September 2010 low.

Lamenting that you missed such a move? You shouldn't. For one, this return merely more-or-less matches the performance of the S&P 500 index over the same time period. More importantly, it's not too late to capitalize on a couple of significant catalysts that will likely send CVS' stock soaring in the coming years.

Ride the generic wave
CVS and other companies that fall under pharmacy benefit management and/or retail pharmacy banners, including Walgreens (NYSE: WAG  ) , Express Scripts (Nasdaq: ESRX  ) , and MedcoHealth Solutions (NYSE: MHS  ) , will likely see significantly better profit margins and increased profitability in the coming years, amid a wave of generic drug introductions between now and the year 2015.

The patents on most of the top-selling drugs in 2010 are scheduled to expire over the next several years. In the short term, this includes the introduction of a generic version of Pfizer's (NYSE: PFE  ) Lipitor, the United States' No. 1-selling drug in dollar terms, in November 2011. The country's third best-selling drug, Plavix, produced jointly by Sanofi-Aventis (NYSE: SNY  ) and Bristol-Myers Squibb (NYSE: BMY  ) , follows in May 2012. In the longer term, the patent on last year's No. 2-selling drug, AstraZeneca's Nexium, is scheduled to expire in 2014.   

It doesn't take consumers long to switch to generic forms of drugs once they are introduced. A recent study published by market intelligence firm IMS Health found that an average of 80% of branded medications' prescription volume is replaced by generic equivalents within half a year after losing patent protection.

The introduction of a significant number of generic drugs will be a boon for a number of companies, because generics are significantly more profitable than branded medications for pharmacies, distributors, and pharmacy benefit managers.

Feel the demographic tailwinds at your back
Not only will the drugs that CVS retails in the coming years be more profitable, but the company will also sell more of them to an aging U.S. population. According to the Census Bureau, the number of U.S. residents age 65 and older is expected to more than double by the middle of the next century, to 80 million. Furthermore, the number of "elderly" people in the country is expected to rise from approximately one in eight in 1994 to one in five by the year 2030.

These older Americans buy more prescription drugs on average than younger individuals. A study by the U.S. Department of Health and Human Services found that the total number of annual prescription purchases (including refills) rises from 9.3 for 18-to-44-year-olds to a whopping 31.6 for 65-to-74-year-olds.

I fully expect CVS to use its expanding customer base and higher-margin products to generate outstanding shareholder returns over the next several years. While several other companies will also benefit from these trends, CVS is cheaper than all of them when looking at a number of metrics, including its P/E and price-to-book value ratios. Furthermore, CVS's earnings have been held back by the lackluster performance of its Caremark benefit management business. Any improvement there, or divestiture of the division, could set CVS' stock aloft.

For related Foolishness:

Fool contributor Jason Knapp encourages you to Just Say No to Drugs, yet owns shares of CVS Caremark. Pfizer is a Motley Fool Inside Value selection. MedcoHealth Solutions is a Motley Fool Stock Advisor recommendation. The Fool owns shares of MedcoHealth Solutions. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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