Developing drugs is time-consuming, costly, and there are no guarantees
of success. Look for companies with long patent lives and full pipelines to
spread the development risk.
Drug companies whose products target large patient populations or sig nificant unmet needs have a better chance of paying off. Make sure you have a big margin of safety for pharmaceutical companies with megablockbuster drugs that make up a large percentage of sales. Any unexpected developments can send cash flow, and the stock price, reeling.
Unless you have a deep understanding of the technology, don't invest in biotech startups. Payoffs could be large, but the cash flows are so far out and uncertain that it's easier to lose your shirt than win big. Don't overlook the medical device industry, which is full of firms with wide economic moats.
Cash is king for firms that rely on development (pharmaceuticals, biotech nology, and medical devices). Make sure firms have enough cash or cash from operations to get through the next development cycle.
Keep an eye on the government. Any drastic changes in Medicare/ Medicaid spending or regulatory requirements can have a deep impact on pricing throughout the sector.
Managed care organizations that spread risk—whether through a high mix of fee-based business, product diversification, strong underwriting, or minimal government accounts—will provide more sustainable returns.
