Every investor shies away from certain sectors. They may seem too complicated, too risky, or too hard. But one sector that can be complicated, risky, and hard still deserves at least a portion of nearly every investor's dollars.
The beauty of pharmaceutical stocks
Analysts always like to preach about the importance of portfolio diversification. There are many ways to diversify a portfolio -- for example, by balancing small-cap investments with more stable blue-chip stocks. It's also important to diversify your portfolio across sectors, and to have at least some exposure to the pharmaceutical sector.
Why? Among other benefits, pharmaceutical and biotech stocks are relatively recession-proof.
That's right: recession-proof
Since people still get sick even when the economy turns sour, investors in drug stocks don't have to worry about the business cycle nearly as much as those with their portfolio heavily invested in more cyclical industries. For instance, from the beginning of 2000 to the end of 2003, the S&P 500 dropped 20% as the economy headed south, briefly dipping into a recession. The AMEX Biotech Index, on the other hand, was up 25% in that time frame, with 100% to 300% gains in shares of drug stocks such as Genzyme (Nasdaq: GENZ), Gilead Sciences (Nasdaq: GILD), and Amylin Pharmaceuticals (Nasdaq: AMLN).
If the recession-resistant nature of drug stocks isn't enough to get you excited, perhaps the high margins and reams of free cash flow that drugmakers churn out every year will.
Because drug development represents one of the few instances where the government will allow temporary monopolies to exist, even operationally challenged large-cap pharmas such as Pfizer (NYSE: PFE) and Johnson & Johnson (NYSE: JNJ) were able to boast stratospheric gross margins above 70%, and operating margins in the 25% range last year. These sorts of high-margin earnings mean loads of free cash flow, which the drugmakers can return to shareholders via dividend payouts or other shareholder-friendly measures.
Something for every type of investor
Whether you're looking for high-risk, high-reward development-stage drugmakers with multibagger share price appreciation opportunities (such as ZymoGenetics (Nasdaq: ZGEN)) or more conservative blue-chip large cap pharmas that pay a juicy dividend (consider GlaxoSmithKline (NYSE: GSK)), there's a drug stock for every type of investor.
It can be hard finding the right drug stocks to invest in, but if you want more Foolish coverage of some of the most innovative biotech and specialty pharmaceutical drugmakers, I invite you to check out the Fool's market-beating Motley Fool Rule Breakers growth investing service. You can view all our recommendations and access our message boards and exclusive content with a 30-day free trial subscription.
Fool contributor Brian Lawler is not an exciting guy at parties and does not own shares of any company mentioned in this article. Pfizer is a Motley Fool Inside Value recommendation. Johnson & Johnson and GlaxoSmithKline are Income Investor picks. The Fool has a disclosure policy.
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