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The Generic Drugs Industry

(January 20, 2005)

Please read our disclaimer before reading the following information.  Be sure to utilize a hard stop in each trade that you make!

Again, readers are encouraged to exchange ideas and views on both our individual "stock picks" and our market commentaries.  This website is not nearly as complete without the participation of our readers!  It is also a great place to get new trading ideas and to explore current ones.  For example, this author posted a short message yesterday morning questioning my outlook of EBAY - right before its earnings report and subsequent dismal performance in the AH market.  Please start posting in our Discussion Forum today!

Dear readers - please note that we sold our 100% long position on January 12th in our DJIA Timing System at 10,530 and are now neutral.  This was posted in real-time on the "Special Alerts" section of our discussion forum.

During 2005, I intend to devote more time and effort to the research of various industries - industries that I believe will take advantage of the great secular trends going forward, such as the aging population, the rise of China and India, and the development of alternative energy sources.  I will also try to emphasize "quality" over "quantity" - as I believe twenty hours devoted to the picking of just one stock is immensely more profitable to my subscribers (and me) than spending twenty hours in the picking of ten stocks.  Picking the right stocks and holding them early in a bull market (whether cyclical or secular) is the method which most people make the most money from the stock market, and hopefully, we will be able to do some of that going forward in the next few years.

In that light, I highly recommend the book "The 100 Best Trends, 2005" by George Ochoa and Melinda Corey.  I have long been interested in the generic drugs industry but picking this book up stirred up my interest, yet again.  Today, I am going to discuss the state of the generic drugs industry.  Next week, I will cover some of the specific stocks in the generic drugs industry and come up with at least one stock that I like.

Anyway, onto our commentary:

It is no secret that the current Administration has been pushing for a continued increase in the shift from brand name to generic drugs in recent years.  The passage of the Medicare reform bill in late 2003 - with its strong generic access provisions - represented a first step in that direction.  Since then, the Administration has continued its efforts.  As reported in the Generic Pharmaceutical Association congratulating President Bush on his election victory last November, "The President has played a leadership role in recognizing the tremendous value generic pharmaceuticals provide to our nation's health care system.  Given that rising healthcare costs remain a priority issue for America's businesses/employers and consumers, we pledge our cooperation in helping the Administration continue its efforts to reduce the cost of prescription drugs through access to safe, effective and affordable generics." This has also been reflected in the increased crackdown of brand name pharmaceutical companies who continually seek patent extensions by using various loopholes in the law.  For example, in a June 2004 monthly report, the Generic Pharmaceutical Association wrote: "Two recent lawsuits filed against GlaxoSmithKline (GSK) are the latest in a series of legal actions taken against brand name pharmaceutical companies who allegedly engage in tactics that delay generic competition. The recent lawsuits filed against GSK involve the antidepressant, Paxil, and the antibiotic, Augmentin. GSK reached a settlement to pay $175 million in another patent dispute earlier this year. Over the past 20 months, Aventis settled patent disputes by paying $110 million and $80 million penalties. In January, 2003, Bristol-Myers Squibb settled an antitrust lawsuit for $670 million."

This continued push for generic drugs makes logical sense, as everyone but the big pharmaceutical companies have a vested interest in seeing a bigger preference for generics - even retail pharmacies - who actually earn a bigger profit margin on generics.  The shift to generics is now at a pace "greater than anything . in the last fifteen years," according to Michael Yellen, senior portfolio manager for AIM Global Health Care Fund, as quoted in "The 100 Best Trends, 2005."

As reported by Merrill Lynch, against this friendly background for generics is the fact that patents for drugs that are worth $9 billion in annual sales is due to expire this year while another $19.5 billion worth is due to expire in 2006.  Merrill Lynch is also bullish on Indian generic drugs manufacturers, as they estimated that the Indian generic companies will develop 82% of the generic equivalents for the drugs whose patents are due to expire in 2005 and 2006.  Interestingly, the two highest growth industries in India are now the technology and the pharmaceuticals industries, as reported in this Forbes Special Report.  The company or companies that we will discuss next week may very well be Indian, as it naturally makes sense to produce generic drugs in India since the labor cost in the generic drugs industry in India is estimated to be only 10% of the labor costs here in the United States.

Finally, I would like to repeat this again.  Readers who have not read my past commentaries should go back and read my last special report titled "Three Important Questions - Economic Survival in the 21st Century" so as to be able to get a background on what I believe will be the great secular trends of the early 21st century - at least secular trends that will affect the average American.  As I discussed in that special report, the aging of the general population is set to continue.  An older population will naturally mean a great consumption of drugs - not only in the U.S. but in virtually all developed countries (in fact, the situation in Western Europe and Japan is more dire than that of the United States).  China, with a population of 1.3 billion people is also set to grow much older in the next few decades.  As income continue to grow in China, they will also eventually become a huge market for all kinds of drugs - but probably mostly generic drugs.  Obviously, the generic drugs industry will be one of the main industries to take advantage of this great secular trend going forward.

Update on the ARMS Index: The one-day ARMS reading actually hit 2.02 today; however the 10-day MA of the ARMS Index actually decreased to 1.19 from 1.24, suggesting that the market is still nowhere near oversold.  The 21-day ARMS, however, is now sitting at 1.17, although it is still far away from the 1.30 level that was registered in late October of last year (and the 1.45 to 1.50 levels that were reached in March and late July of last year).

Happy Trading/Investing!

Henry To, CFA

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