Generic Drugs: Investing Essentials

Can low-priced drugs equal big profits for investors? Potentially, if you know what to look for within the generic drug industry.

Aug 1, 2014 at 12:00AM

With healthcare costs rising, physicians and consumers are constantly looking for effective ways to manage medical cost inflation. Generic drugs may offer one piece of the puzzle to that solution.

Because of their attractive costs relative to branded drugs, and considering the world's population is increasing and living longer, we can probably expect an ever-increasing role for generic drugs in healthcare.

But investing in generic drug manufacturers is only prudent if you first understand the ins and outs of the industry -- so let's take a look at the main points.


What are generic drugs?

Perhaps the U.S. Food and Drug Administration says it best: "A generic drug is identical -- or bioequivalent -- to a brand name drug in dosage form, safety, strength, route of administration, quality, performance characteristics, and intended use."

New drugs are protected by patents for a set period of time. Once the patent expires, generic drugmakers are able to swoop in and offer a cheaper version of the drug as long as it meets the laundry list of critical FDA standards mentioned above.

What is the history of generic drugs?

If you've ever picked up a generic drug prescription from your local pharmacy and appreciated the favorable difference in costs between generics and brand-name drugs, then you might want to thank the Drug Price Competition and Patent Term Restoration Act of 1984 for saving you money.

This law, which is better known as the Hatch-Waxman Act, allowed generic drug developers to submit abbreviated new drug applications, or ANDAs, to the FDA in order to request approval for their generic versions of branded drugs. ANDAs allow generic drug developers to avoid costly and time-consuming animal and human clinical testing which can expedite the approval process and also help keep the cost of bringing a generic drug to market down -- leading to savings for consumers.

How many generic drugs are there?

The simple answer is: "A lot!" Using the entire world as a scope, there are thousands of generic drugs available to be prescribed to patients today. And, because patent periods are finite on branded drugs, it means that the pool for new potential generic drugs is always growing.

Because of their high price point, brand-name drugs will always represent a big percentage of total pharmaceutical sales. But the vast majority of all filled prescriptions in the U.S. are for generic drugs.

Why invest in generic drugs?

Now that you have a better understanding of what a generic drug is and how they've come to dominate the number of prescriptions written today, let's consider a few of the advantages associated with investing in generic drugmakers.

Generic Drug

Source: U.S. Food and Drug Administration

The first advantage, as mentioned briefly, is that generic drugmakers' pipelines are practically limitless. At some point all branded pharmaceuticals will lose their patent protection, which can expose those innovator companies to generic competition. Having a limitless pipeline means generic drugmakers have many targets and opportunities.

Also, the cost that goes into developing a generic drug is minimal relative to brand-name drugs. By avoiding expensive and time-consuming trials, generic drugmakers can focus almost their entire effort on production and plotting which upcoming patent expiration to tackle next.

And lower costs help generic drugmakers price their therapies at a fraction of branded competitors. Although generic drugmakers' gross margins are much lower than their branded drug counterparts due to the lower price point, generic drug producers make up for their lower margins with impressive sales volume. That lower price point creates a big incentive for consumers and physicians to opt for generic drugs when they're available.

Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

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4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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