October 6, 2006 2:43 PM
How Mid-Term Election Will Affect Drug Companies
Stock investing is tough enough when you have to deal with the specifics of a company and an industry. When you throw politics into the equation it becomes a whole new ball game. Now stock investing can be a crap shoot at best. Let’s take a look at what’s going on currently, and you decide. First let’s look at a little history.
For the better part of 50 years, the drug industry has been nothing short of a fabulous stock investment. Whether it was Johnson & Johnson, Pfizer, Merck, or any one of a dozen other drug companies that developed into giants, you would have made a killing with these stocks. One of these companies Johnson and Johnson is the best performing publicly traded stock of the last 100 years with a compounded growth history surpassing 15% per year.
It was a simple concept, but yet difficult to execute. These companies created drugs and then marketed them via advertising to a captive audience of doctors, and their captive audience the patients. As a stock investment, the industry was basically unsurpassed. The reason is that every other high tech investment as a rule had a longevity of about 7 years. Technology can obsolete technology very easily as you know.
This was not true of drug manufacturers, where it takes a long time to bring a drug to market. You then have a long patent life, and usually you can extend that patent life at least once. Big Pharma as the drug companies came to be called were making a fortune, and the stockholders with them. When it came to stock investing, you couldn’t own enough of these wonderful companies.
It all started to change in the 1980’s. A marvelous new, but small industry started to emerge called the biotech industry. Rates of growth for Big Pharma started to slow down. Something was needed to kick-start the drug industry once again, and the Federal government was more than willing to lend a helping hand.
By the 1980’s government had become big sponsors of drug research. Our government had poured billions of tax payer dollars into supporting basic and applied research at the college, and university level. Myriad PhD’s were hired, laboratories built, and graduate students employed to go find, and develop the next marvelous drug.
Congress then passed a law that mandated that the discoveries taking place in these government sponsored research labs (usually the top 50 colleges in the United States) would have to be given to the giant drug companies for final testing, and distribution. This meant that Big Pharma would be the recipient of all this largess bestowed on the government labs. The giant drug companies would be the direct beneficiaries of tens of billions of dollars of citizen sponsored research. It was the best of all worlds.
Throughout the 1980’s, and 1990’s, these actions sustained the growth of the major drug companies. Unbeknownst to the general citizen, the major drug companies come up with less than 5% of all the major drugs sold in this country. The real creators have been those government sponsored labs, and the small bio-tech companies that have been spawned everywhere.
Even with the giant government outlays, by the beginning of the 21st century, we started once again to see a slow-down in growth rates for Big Pharma. What was needed was a shot in the arm. In 2003, the federal government supplied the adrenalin, and the drug companies were only too glad to accept it. Congress passed a new part III to the Medicare law which meant that the government was going to start picking up prescription drugs for citizens 65 years of age and older. This program would cost tens of billions of dollars.
More importantly, the government would not be allowed to negotiate the prices of the drugs that they would pay for under the act. This meant that the drug companies would be able to charge BILLIONS OF DOLLARS more than if they had to negotiate. It was the ultimate bonanza for the drug companies, and their profits were inflated by billions. As an aside, the program also called for insurance companies to come in between the user which was the senior citizen, and the Medicare program. This was a successful attempt to also reward the insurance industry with billions in profits.
Democrats may have last laugh?
The problem is that it seems likely that the Democrats will take over the House of Representatives in November. If successful, they have already stated their intent to change the program immediately. The Democrats want the federal government to now have the right to negotiate lower drug prices on behalf of the senior citizens. This will result in lowering drug company profits to the tune of billions of dollars.
Here’s the wild part of the whole deal. For decades the Democrats wanted to create a prescription drug coverage program as part of the Medicare Program. They couldn’t get it done. They tried, and tried, and failed, and failed. It took the Republicans to do it, but they only did it, to benefit the drug companies, and the insurance companies as well. Now that the Democrats may take control, they will have the opportunity to roll back the drug companies participation in the outlandish profits they are making. At the same time, the Democrats will be able to keep a program in effect, that they desperately wanted, but could never make happen on their own.
It’s fascinating how what seems to come around, always goes around. Our advice is don’t be caught dead owning drug stocks if the Democrats take over the House in the November election. They are in for some ride on the downside, as we all will be watching the granddaddy of federal giveaways get taken away.
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