Investors often comment that we sometimes differ with the mainstream view on which stocks make good investments. That’s especially true with drug stocks.

The general view on these stocks seems to be that they are can’t-miss investments because the baby boomers are reaching an age when they will need drugs for a number of medical conditions, and are willing to pay for them. As well, some investors feel that these companies stand to benefit from developing treatments for new diseases, such as the H1N1 influenza virus.

(Below, we spotlight a stock that’s making a vaccine for H1N1, but faces fewer of the risks of drug companies. Read on for further details.)

You can learn more about how we judge a stock’s investment quality in our FREE special report, “Canadian Stock Market Basics: How to Trade Stocks and Make Good Investments in Canada.”

High development spending can hold back many drug stocks

We agree that the aging of the boomers will create demand for drugs, and that some drug firms will benefit from treating new diseases like H1N1. But there are several drawbacks to drug companies that you should keep in mind if you are thinking of investing in them.

In particular, drug firms need to spend heavily to create new drugs, and spend even more to gain regulatory approval. Even then, they only get to profit for a limited time before patents run out and generic products appear. Then too, their research spending may lead to dead-ends, rather than new drugs that fill a need and can overcome the regulatory hurdles.

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In addition, demand for effective drugs can evaporate overnight, long before the patent expires, if more effective drugs come along. Unlike many other manufacturers, drug stocks don’t benefit from brand loyalty.

However, if you want to invest in drug stocks, we think you should focus on those that have high cash holdings and a number of drugs in the pipeline. All the better if they have access to fast-growing markets, like China, India and Latin America.

Medical-supply firms are often a better choice than drug stocks

Instead of drug stocks, consider medical-equipment suppliers. Demand for medical equipment tends to grow, or at least hold steady, regardless of swings in the overall economy. Many of these firms also get recurring revenue, mainly from long-time customers. They also face little competition from generic products.

Baxter International Inc. (symbol BAX on New York) is one example of such a stock. We’ve updated our buy/sell/hold advice on Baxter in our current Wall Street Stock Forecaster newsletter.

Like drug companies, Baxter makes vaccines and other pharmaceuticals. But these only account for 43% of its revenue. It gets the rest from intravenous equipment and systems, as well as dialysis equipment. This lowers its risk. Even so, the company continues to benefit from treatments for new diseases. European health regulators have recently approved its H1N1 vaccine, and ordered several million doses.

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