High costs, strong competition, and a lack of brand loyalty make pharmaceutical penny stocks very speculative investments, even if the company has a drug that’s reached commercialization

Major pharmaceutical companies are a more-speculative investment than most investors realize. They need a continuing flow of successful new products to maintain their earnings. They face increasing litigation and aggressive competition from generics as drugs come off patent. Unlike tech stocks, they have formidable regulatory burdens, and unlike other manufacturing stocks such as, say, auto companies, they do not benefit from customer loyalty.

Pharmaceutical penny stocks are even more speculative, and come with a variety of problems beyond the usual penny stock problems. Successful Investors should be aware of the risks.

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3 big problems with pharmaceutical penny stocks

Even though the aging of the baby boomers will further increase demand for pharmaceutical drugs, there are drawbacks to drug company stocks and in particular pharmaceutical penny stocks. Here are three major hurdles most drug stocks face:

1. High research and regulatory costs: 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. Also their research spending usually leads to dead ends, rather than new drugs that fill a need and can earn the approval of regulators. Failed research may add to the general body of knowledge, of course. But for the company that spent the money, it’s a writeoff.
2. Aggressive competition: Drug companies must deal with increasing litigation and aggressive competition from generics as patents on their drugs expire.
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, drug stocks don’t benefit from brand loyalty. What’s more, if investors come around to the common-sense view that the best treatment for diabetes is a combination of improved diet, more exercise and fewer calories, they may lose their appetite for the high risks of drug stocks. 

Increased risk with pharmaceutical penny stocks

As mentioned, drug stocks are riskier than investors realize. The cost of developing a new drug is huge, and the payoff, if any, is uncertain. That’s even more so with pharmaceutical penny stocks, which typically have just one or two drugs under development—and in very early stages with eventual commercialization very unlikely.

If you lose money in speculative or other low-quality stocks, you may think your main mistake was bad timing. That’s a misconception. You can get lucky in penny stocks, just as in lotteries. But if you play long enough, the “house odds” eventually triumph over any run of luck.

Sometimes you might get lucky for a short time—for example, in the early 2000s, buyers of Internet start-ups made far more profit than investors who stuck with well-established companies.

In pharmaceutical penny stocks or games of chance, the odds are against you. So, time works against you. The longer or more often you play, the likelier you are to lose.

That’s also why we think you should apply our sell-half rule.

Selling half your holdings after you double your earnings is a good strategy for any high-risk investment, but especially so for penny stocks.

Invest in these types of health-care stocks instead of pharmaceutical penny stocks

If you want to invest in drug stocks as part of a Successful Investor portfolio, we think you should focus on those that have high cash holdings, an established portfolio of drugs without near-term generic competition and a number of other up-and-coming drugs in the pipeline. All the better if they have access to fast-growing markets such as China, India and Latin America.

While pure drug stocks can be risky, other fields of medicine and health care can offer a number of other stocks we recommend that meet our Successful Investor criteria. For example, we like health-care stocks with recurring revenue, which can come from the sales of lab supplies, maintenance on equipment or other sources. We feel that these revenue streams can be quite secure.

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