Clinical Trial Failures Don't Bother These Companies

Clinical trials are the lifeblood of any drug developer. Their stocks rise and plummet on the results. But there's one industry where companies get paid whether drugs fail or succeed. These companies still have to interact with the FDA, so on one hand they don't have it quite as good as lab supply companies, which don't have to deal with the agency. But on the other hand they have it better, because the market served by these companies could actually grow faster than drugmakers develop drugs.

I'm talking about contract research organizations (CROs), which are essentially outsourcing companies hired by pharmaceutical and biotech companies to run pre-clinical tests and clinical trials for them. The constant expansion and contraction of clinical trials as drugs enter and leave the clinic can wreak havoc on the budgeting for companies -- especially development stage companies like Exelixis (Nasdaq: EXEL  ) .

By hiring a CRO, the drug company mitigates its risk of layoffs if the drug fails. The CROs in turn reduce their risks by having multiple clients so that when one trial ends, staff just moves onto the next trial.

Missed the boat?
Are you ready to jump on board the CRO boat to an early retirement? It looks like that boat has left the dock.

Company

Year-to-Date Return

EPS Growth

Caps Rating (5 max)

Covance (NYSE:CVD)

48.2%

18.8%

*****

Parexel International (NASDAQ:PRXL)

54.2%

58.0%

*****

Pharmaceutical Product Development (NASDAQ:PPDI)

32.0%

11.4%

*****

All data courtesy of Capital IQ, a division of Standard & Poor's, and Motley Fool CAPS. EPS (earnings per share) growth is one-year growth for the trailing 12 months excluding extras.

With growth like that, you can see why Motley Fool CAPS players have given all three stocks our highest rating of 5 stars. In fact, if you combine the ratings from all three companies, a whopping 99% of the ratings are for outperform.

The big question is: Will the performance continue from here?

Future growth
With Amgen (Nasdaq: AMGN  ) and Johnson & Johnson (NYSE: JNJ  ) , among others, cutting costs, you might think this would be a horrible time to invest in companies that sell products to biotech and pharmaceutical companies. But decreased spending doesn't mean that the companies will stop developing drugs, just that they'll try to do more with less. That sounds like just the job for outsourcing companies.

CROs also have a partner in their growth prospects: the FDA. As the agency increases the requirements for approval, it's likely that more clinical trials will be needed. 

The prospects get even better because the agency is increasing the number of trials available for CROs to perform after drugs are approved.

Drug company investors have almost certainly heard of phase 1-3 clinical trials that determine if a drug will be approved by the FDA, but since Merck's (NYSE: MRK  ) Vioxx was pulled from the market, a new type of trial has become more common: the dreaded phase 4.

After the FDA approves a drug, the agency often requires the drugmaker to continue to study the safety of the drug in trials dubbed phase 4. Since drugs that have made it this far usually have side effects in a small amount of the patients, these studies are usually quite large and last many years, making them quite expensive.

With the reauthorization of PDUFA giving the FDA increased authority to regulate drugs post-marketing, I'd expect phase 4 trials to increase substantially in the coming years. If CROs can capture some of that increase, the industry could actually grow faster than the increasing rate of drug development.

Final Foolish thoughts
While I've made it sound as if CROs are the perfect stocks for investors who like the idea of investing in a recession-proof field, but can't stomach the ups and downs of clinical trials, that's not entirely true. The CROs sometimes make deals with the drug companies to reduce or eliminate their fees in exchange for royalties on drugs if they make it to the market. If the thought of clinical trials scares you, do your due diligence and make sure you're investing in one of the companies that doesn't make these sort of deals.


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