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Health care among early leaders in the S&P 500

Published on NewsOK Modified: January 27, 2013 at 12:49 pm •  Published: January 27, 2013

The worst of the impact of patent expiration may now be over for the drugmakers, and the market has already factored it into stock prices, says Mark Bussard, a health care analyst at fund manager T. Rowe Price.

"The 'patent cliff' for most of the companies has now come and gone," says Bussard, who is a physician by training. "Some of the largest losses to generic competition are in the rear-view mirror now."

Approvals for first-of-a-kind drugs have also been climbing as drugmakers continue to pursue an emerging business model focused on treatments for rare and hard-to-treat diseases.

The Food and Drug Administration approved 39 new drugs last year, up from 30 the year before and the highest annual tally since 1997, when the agency also approved 39 drugs.

In addition to being relatively low-risk investments, due to the steady demand for drugs, Big Pharma also pays big dividends.

The largest drug companies in the S&P 500 have higher dividend yields than the broader index, which yields 2.1 percent. Pfizer currently has a 3.6 percent yield and Merck & Co. yields 4 percent.

Biotechnology companies are possibly the most exciting companies in the sector and are also advancing.

Investing in this sector can be challenging, though, as the vast majority of drugs being developed don't work out.

"It's probably unwise ... to try to pick the individual winner," says Sam Isaly, the manager of Eaton Vance's Worldwide Health Sciences Fund. "It depends on whether you're a lotto player or not."

While the Affordable Care Act ensures that money will flow into the industry in the near term, that spending can't keep rising exponentially. At some point, the focus will turn to the cost of the reforms, particularly if the initial spending estimates are exceeded, causing renewed uncertainty for the industry.

"That's a longer-term concern that is going to come into play at some point," says Invesco's Taner. "Right now we're in the honeymoon period. People aren't thinking about that."

And if history is a guide, the cost estimates will likely prove too low.

Upon passing the Medicare bill in 1965, the House Ways and Means Committee estimated total program expenditures would amount to $1.3 billion in 1967. That estimate proved to be "wildly optimistic," with the actual cost coming in at $4.6 billion, according to research by Citigroup health care analysts.

To counter the rising costs, governments and employers will increasingly try to shift more of the cost to individual consumers, transforming the industry from an "employer-driven insurance market" to an "employee-driven consumer market," says Eddie Yoon of Fidelity.

"The companies that are the most innovative in helping drive costs down are going to be the growth companies of tomorrow," says Yoon, who manages the investment firm's Select Health Care Portfolio.


AP Business Writers Matthew Perrone and Linda Johnson contributed.