Many investors think drug stocks are can’t-miss investments. That’s 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.

We agree that the aging of the boomers will create drug demand. But there are several drawbacks to drug stocks that you should keep in mind if you are thinking of investing in them. Here are three major hurdles most drug stocks face:

1. High research costs: Drug firms need to spend heavily to create new drugs. 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.
2. Regulatory risk: Drug stocks whose success depends on drugs that are currently in clinical trials expose you to huge risk. Not only are the chances of success in trials remote, the U.S. Food and Drug Administration (FDA) has become more cautious in approving new drugs following Merck’s 2004 voluntary withdrawal of heart drug Vioxx due to side effects; the FDA approved Vioxx in 1999. This heightened FDA caution adds further risk to new drug investments.

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3. No brand loyalty: Demand for effective drugs can evaporate overnight, long before the patent expires, if more effective drugs come along. Unlike many other manufacturers, like car companies, say, drug stocks don’t benefit from brand loyalty.

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

But better still, instead of investing in drug companies, consider medical-equipment suppliers. Like drug firms, medical-equipment suppliers are well-positioned to profit from the aging of the baby boomers. Moreover, demand for medical equipment tends to grow, or at least hold steady, regardless of swings in the overall economy. Many medical-equipment companies also get recurring revenue, mainly from sales of supplies and parts. They also face little competition from generic products.

Baxter International Inc. (symbol BAX on New York) is an example of a well-established medical-equipment supplier. We analyze the company in our Wall Street Stock Forecaster newsletter.

Like drug companies, Baxter makes vaccines and other pharmaceuticals. But these only account for about 45% of its revenue. It gets the rest from intravenous equipment and systems, as well as dialysis equipment.

You can get our full analysis of Baxter, including our clear buy/sell/hold advice, when you subscribe to our Wall Street Stock Forecaster newsletter. What’s more, you can get one month free when you subscribe now. Click here to learn how.