For generic-drug companies, margins are ultimately everything. The business is built on volume and how efficiently a company can produce copycat drugs.

Those margins become especially important as companies expand externally; there has to be margin-increasing synergies to justify the acquisition.

So far, Teva Pharmaceutical (Nasdaq: TEVA) seems to be doing everything right. The addition of German drugmaker Ratiopharm in the third quarter helped boost sales 20% over the year-ago quarter, but adjusted EPS increased a whopping 46% year over year.

Recent launches of new products -- generic versions of Pfizer's (NYSE: PFE) Effexor XR, AstraZeneca's (NYSE: AZN) Pulmicort Respules, Shire's (Nasdaq: SHPGY) Adderall XR, Merck's (NYSE: MRK) Hyzaar and Cozaar, and Bayer's Yaz -- helped increase the gross margins. But Teva's real key is that it also has branded drugs, which help boost its gross margins especially compared to other generic-drug makers.


Gross Margins (Last 12 Months Reported)

Teva Pharmaceuticals 58.1%
Watson Pharmaceuticals (NYSE: WPI) 45.1%*
Mylan (Nasdaq: MYL) 40.1%

Source: Capital IQ, a division of Standard & Poor's. *As of June 30.

There's more potential gross margin expansion on the way. Teva announced last week that it was acquiring Merck KGaA's women's health division, Theramex. The branded products should fit well with the women's health products Teva acquired a few years ago in the purchase of Barr Pharmaceuticals.

Everything isn't perfect with Teva's business: European governments are cutting costs, which is cutting into generic drug prices. But as long as Teva can keep launching new generics and expand sales of its branded products, the bottom line should continue to increase faster than the top line.

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Pfizer is a Motley Fool Inside Value selection. The Fool owns shares of Teva Pharmaceutical Industries. 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.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. The Fool has a disclosure policy.