The Truth About the Drug Companies – Book Review

The  Truth About the Drug Companies: How They Decieve Us and What to Do About it is a controversial book from Dr. Marcia Angell. The book tries to expose the big pharmaceutical companies by showing the reader how they generate massive profits.

Summary

During her two decades at The New England Journal of Medicine, Dr. Marcia Angell had a front-row seat on the appalling spectacle of the pharmaceutical industry. She watched drug companies stray from their original mission of discovering and manufacturing useful drugs and instead become vast marketing machines with unprecedented control over their own fortunes. She saw them gain nearly limitless influence over medical research, education, and how doctors do their jobs. She sympathized as the American public, particularly the elderly, struggled and increasingly failed to meet spiraling prescription drug prices. Now, in this bold, hard-hitting new book, Dr. Angell exposes the shocking truth of what the pharmaceutical industry has become–and argues for essential, long-overdue change.

Why Read This book?

Healthcare sector is one of the hottest sectors in the market and I am bullish on the sector going forward. The pharmaceutical subsector is one of the most, if not the most, profitable industry of the economy. The aging populations in the western world, increase in diseases in the populations across the world coupled with rise of newer diseases discovered provide this sector with a bright future. I picked up this book to get a better understanding of how Big Pharma works and generates its profits. This turned into a great read, albeit a bit repetitive where the author goes on case after case to illustrate the industry’s operations. Nevertheless, the book provides a rich resource with plenty of references to illustrate such points.

Takeaways From the Book

  • Big Pharma has HUGE margins. The author shows how a drug that is shown to cost $800M for development really turns out to be approximately $100M.
  • The same drug costs more in the US than other parts of the world because the market can support it.
  • So, why do you think drugs are expensive? Did you say R&D? The pharmaceutical industry spends enormous amounts of its money on marketing and “educating” the public – which is just another way of covering marketing and propaganda costs as R&D.
  • Most diseases follow this path: (1) Understanding the disease; (2) Discover and develop a promising chemical composition to cure it; and (3) Commercial development and marketing.
    1. Understanding the disease: Most research is performed by National Institute of Health (NIH) and the leading universities across the world. NIH is an agency of US Dept of Health and Human Services and is completely funded by the US taxpayers. Big Pharma enters into the picture after a disease is well understood which can take anywhere between a few years to a few decades.
    2. Discover/Develop a promising chemical composition: It is usually universities and small biotech firms that discover a chemical composition that sounds promising.
    3. Commercial development and licensing: Big Pharma signs up as licensed manufacturers and distributors taking over from the universities and small biotech firms.
    4. It is at this point that the Big Pharma patents the drug, runs clinical trials in multiple stages and pushes for FDA approval, commercial development and sale to the public.
  • Patents are a big part of the Big Pharma’s expense and source of revenue protection. It is an expenses because drugs usually have to be patented before running trials. Its difficult to keep the recipe a secret once its out in the public domain. Once a drug is successfully trialed, the companies push for fast approval from FDA as they have time limits for the exclusivity due to patents, after which generic drug companies can start releasing copy-cat drugs.
  • The me-too or copy-cat drugs need to only show that its effective against placebo not older drugs once patent has expired. Drugs coming off patents usually just remove or tweak the inactive ingredient and get a new patent. Then its just a matter of “educating” doctors and patients of the better drug.
  • Changing a disease condition can create or expand the market for drug manufacturers. The author lists how a new market was created by defining a pre-hypertension for people just under the threshold for the hypertension drugs. Similarly, the cut off for cholesterol has been lowered over the years to expand the market for cholesterol drugs.
  • The book also discloses extremely controversial and shocking testing conditions where the drug companies take up on the US governments offer of extending patents by 6 months when the study includes children. The drug companies have been reported to test drugs to combat conditions such as heartburn, premenstrual conditions etc which do not affect children in any way.
 

Recommendation

From an investor’s perspective, this book does not really provide any direct correlation for how or what drug companies to invest in, but provides a fantastic internal view of how the drug companies markup their products and have grown their influence. If you invest in the healthcare sector, this book is a must read. Even if you do not, it is a great read for a part of the economy and industry that directly affects our livelihood in one way or another. Granted that the book is written to be controversial to generate a buzz and increase sales, and most arguments presented are one-sided, I think its still worth the readers time and money.

Dividend Comparison – Pharmaceuticals

The pharmaceutical industry is one of the most profitable industries where they have a huge margin on their products. The figure below is taken from Jeff Gundlach’s What in the World is Going On? presentation from Jun 4, showing the relative profitability between various industries.

Profitability by industry

I hold some of my equity in mutual funds which I am planning on selling in the near future. The mutual fund is a globally diversified healthcare fund, which holds equities in medical equipment and pharmaceuticals. Once I sell the mutual fund, I intend to pick up shares of individual companies in the medical equipment and the pharmaceutical industry. This post of dividend comparison gives an overview of the pharmaceutical industry.

Withholding Tax

The foreign company ADRs withhold a tax rate depending on the country of origin. For each of the entries below, I have added a country listing and the withholding tax rate associated. The number in the column indicates the withholding tax rate if the security is held in a RRSP registered account. Note that the withholding tax is zero for all US and UK companies due to the tax treaties between those countries and Canada. The number in the brackets is the withholding tax rate if the security is held in a TFSA or other non-registered accounts.

Drug Manufacturers – Major (Big Pharma)

The following companies are the Big Pharma drug manufacturers with a market cap of $2B+. The list excludes one other major manufacturer (Roche Holdings AG) – excluded due to the fact that it trades in the OTC market.

Company Name Ticker Quote P/E Yield Payout Ratio 5-yr DGR Country Withholding Tax
AbbVie ABBV $43.91 12.95 3.64% 59% USA 0% (15%)
AstraZeneca AZN $48.94 10.83 5.72% 61.9% 8.41% UK 0% (15%)
Bristol-Myers Squibb BMY $44.86 50.98 3.12% 156.8% 2.81% USA 0% (15%)
GlaxoSmithKline GSK $52.29 21.00 4.49% 66.5% 1.55% UK 0% (15%)
Johnson & Johnson JNJ $89.24 24.25 2.96% 64.7% 7.87% USA 0% (15%)
Eli Lilly & Co LLY $51.42 12.33 3.81% 47% 1.83% USA 0% (15%)
Merck & Co MRK $47.96 24.47 3.59% 84.9% 2.38% USA 0% (15%)
Novartis AG NVS $72.30 18.49 3.36% 58.1% 9.56% Switzerland 15% (35%)
Novo Nordisk NVO $161.56 22.69 1.97% 31% 27.26% Denmark 15% (28%)
Pfizer PFE $28.44 20.17 3.38% 38.5% -5.49% USA 0% (15%)
Sanofi SA SNY $50.99 25.50 3.52% 88.3% 1.89% France 15% (25%)

Drug Manufacturers – Other

The pharmaceutical companies listed here are $2B+ drug manufacturers classified as Other. They are either a specialty or generic drug manufacturers.
Company Name Ticker Quote P/E Yield Payout Ratio 5-yr DGR Country Withholding Tax
Allergan Inc AGN $89.32 23.88 0.22% 4.3% 0% USA 0% (15%)
Dr. Reddy Labs RDY $37.49 22.86 0.71% 15.2% 28.03% India 25%
Teva Pharmaceuticals TEVA $38.77 19.39 2.91% 56.1% 20.1% Israel 15% (20%)

My Thoughts

Some of the Big Pharma like BMY  have their payout ratios completely out of whack and are currently very expensive at a P/E ratio of 50.98. Staying away from that is a no-brainer as a dividend cut is more probable than not. There are some gems in the Big Pharma industry which are attractively valued such as AZN and NVS, and have a decent 5-yr DGR. However, there are few more considerations that need to be accounted for – including the withholding tax rate. Past performance does not guarantee future trends as each company’s drug portfolio needs to be considered. How many profitable drugs are going off patent in the near future resulting in loss in revenue? If there is a blockbuster drug coming off-patent, how much was it contributing towards the previous year’s revenue? How many new drugs are on their way? Pre-clinical vs. clinical trial stage of the drugs etc.

Disclosure: My healthcare mutual fund holds various big pharma stocks. I do not own any individual stock.

Image source: Jeff Gundlach’s What in the World is Going On? presentation from Jun 4, 2013.

Disclaimer: The information provided here is for educational purposes only. All opinions here are my personal opinions and should not be taken as financial advice. I am not qualified to be a financial advisor. Always consult with your financial advisor before investing in any of the companies mentioned on this blog.