The Tale of Teva

Generic drug company Teva Pharmaceuticals (NASDAQ:TEVA) has had an up-and-down ride for the last few weeks. Teva reported Thursday its third-quarter earnings of $0.38, $0.03 better than the analysts' consensus of $0.35. Revenues rose 53% year-over-year to $1.25 billion, which topped the $1.19 consensus. More good news: Management raised earnings guidance from $1.35-$1.37 to $1.43-$1.44 and nudged up revenue guidance slightly. So, naturally, in the face of all that good news, the stock dropped by $0.22 in Thursday trade.

Teva's good fortune hit a bump in the road when rival Andrx (NASDAQ:ADRX) got pummeled with a bad earnings announcement, and, as is often the case, Teva traded down in sympathy.

The group has received a lot of negative attention lately. Perhaps also putting the group under the microscope has been the meltdown occurring with the major drug companies such as Merck (NYSE:MRK) and Pfizer (NYSE:PFE).

I have written previously about what I believe is the sorry state of large U.S. drug companies. If I want to have a diversified portfolio, I can't let my belief keep me from having exposure to the sector. While most health care has been in a funk for a while, there are several subgroups within the health sector, such as biotech, medical devices, or health-care providers, that may offer a way to get exposure to the group without the headline risk associated with the big drug companies.

I think generic drug companies such as Teva offer a better chance for growth too. The health-care sector is an obvious play on the aging of the baby boomers. Their medical needs will increase dramatically over the next 10 to 30 years. I am not telling you anything you don't know, right?

What makes generics so compelling is that all successful drugs come off patent at some point, and when they do the generics are there to capitalize. The drugs that are not successful, for whatever reason, will have no generic demand. The major drug company has to take the risk of a drug failing, not the generic drug maker. I believe this accounts for the generic's superior performance over the past few years. While this is not foolproof, I do believe a good way to look at this is that generic drug companies take far less single-drug risk than the majors.

Fool contributor Roger Nusbaum is an investment manager and wildland firefighter in Prescott, Ariz. At press time, he personally did not own any of the stocks mentioned, but his clients own Teva.