Today, let me dive a little into the topic of income-investment and why I believe that every income-focused investor should have some pharma stocks in his or her portfolio.
As my readers know, my goal is to escape the rat race with the help of investments in the stock market. With my eyes targeting financial independence, having a passive stream of income is crucial. One way to get it is to invest in dividend-paying companies. The strategy is called income-investing and it is a reliable strategy of building up passive income, large enough to be able paying bills (and more) once the decision to retire has been made.
When it comes to income-investing ideas, how to pick a stock, and what one needs to be aware of, the pharma industry emerges quickly as a good direction to look at.
Profits for years to come
My personal portfolio contains shares of two pharmaceutical companies: AbbVie (ABBV) and GlaxoSmithKline (GSK). They are not THE biggest in the industry, but large enough to reward their shareholders with frequent dividends for many years now. And chances are good that this won’t change anytime soon.
Big Pharma is a term that is being used in a mostly negative manner. Overcharging customers, abusing their power, and either way, health should be free for all, shouldn’t it? Maybe. Maybe not. But what is pretty certain is that this industry has a tremendous cash-flow that is only increasing with a growing and ageing population.
People get sick. It’s how humans work. We get sick, we get better. For most of the time anyway. But the part of getting better for most of the time involves medications, treatments, surgeries, vaccines, anti-biotics, hospital stays. It’s a never-ending battle that will always require someone to develop, produce and distribute all those essential products that help us to have a long and healthy life.
They can do what no one else can
Some people may think that supporting Big Pharma can’t be the only way to get things done. Some smaller companies should be able to pull it off as well, right? Research, development, production, distribution. Well, the bad news is, that smaller companies simply can’t do all this. And even if they try to share the work process with other companies, chances are that they either fail or can’t make enough profit for a sustainable contribution.
There was a recent story about a company called Achaogen that comes to my mind. The company was working on a new type of antibiotics. The scientists and researchers were looking for a way to develop a new type of antibiotics, as the currently widely available versions are becoming increasingly less effective. They were largely successful in the beginning but failed after a very short time in operation. The business was just not profitable enough to sustain.
This case highlights the need for some for really large economies of scale, cross-incentives among products, and distribution scale that a small company simply can’t sustain. And we are talking only about antibiotics. How about those much larger and even more cost-intensive projects. Cancer, HIV, dementia. There are so many challenges in front of us. They require the right people, with the right education and research experience, the right equipment, sufficient funding, the right connections for distribution and the stamina to dive through ups and downs of the world without going bankrupt.
Bill Gates, for example, is working closely with many companies including GlaxoSmithKline through his Gates Foundation. When asked about the reason for this collaboration instead of just using his immense wealth to simply find solutions on his own, he said it very simply: These companies can do things that no one else can do.
This is a powerful statement for any investor out there. It says that, to a large part, there are not many alternatives. That’s a big moat to cross and perfect protection for any long-term investor.
The risks are limited
Unsurprisingly, AbbVie and GlaxoSmithKline are both considered to be rewarding long-term investments for income investors not only by me but by pretty much every analyst out there. The combination of the long-term focus, available resources, knowledge and power of distribution, together with a reliable and stable cash-flow give pharma companies excellent risk/reward ratios.
Some analysts point out that the big cash-cows might at some point disappear, especially when cheaper alternatives come to market. When patents run out. When the competition catches up. These concerns are legit. It will happen. But unlike some electronic toys or tools, health is a different story with plenty of areas that are still under development and which are almost impossible to copy in a simple and cost-efficient process. The electronic cycle for product improvement is only roughly 1 year and has very limited regulations in place. Health related products take 10-15 years to develop and are subjected to heavy approval processes and regulations. This will always keep the competition at pace, even if some profit margins might occasionally suffer or take a blow.
Disclosure: I own all stocks mentioned in this article.