In this piece, we will take a look at the 10 cheap pharmaceutical stocks to buy according to short sellers.
The pharmaceutical industry is one of the most interesting sectors to invest in. This is because while most industries can easily be broadly categorized into either being vulnerable or resilient to economic headwinds, pharma companies have the potential to operate in both categories. Firms that develop new drugs, particularly those that operate in the biotechnology industry, don’t do well in a tough economy as they find it difficult to raise capital and keep costs under control. At the same time, large pharmaceutical companies and those that develop and sell generic drugs can survive in a tough economy due to the relatively inelastic nature of their product demand.
As is with all other industries, the pharma industry has also changed throughout the past few decades. This change has been driven by the rise of biotechnology and biopharmaceutical companies that are seeking to open new frontiers for drug development. Before we get to the data, some of the shifts that have taken place include increased spending on acquisitions as opposed to solely on research, a global industry where multinationals operate in multiple markets, and marketing campaigns that seek to extend product life cycles as opposed to maintaining competitive advantage through patents.
Talking about data, biotechnology has been catching up to the pharma sector in terms of revenue, as it accounted for 30% of total pharma sales in 2014 compared to less than 1% in 1991. At the same time, biotechnology operating margins have also been catching up. These ranged between roughly 7% to 12% between 1991 and 1993, were in the red for the next decade until 2024, and surpassed pharma margins of roughly 24% in 2014 to sit at approximately 28%. This gap widens when we remove the impact of R&D which disproportionately impacts biotechnology companies, as for the five years between 2010 and 2014, the pre R&D operating margin of pharma companies declined from 40% to ~28% while the corresponding value for biotechnology firms grew from 40% to ~56%.
During the same time period, biotech firms’ growth to R&D ratio (which measures the growth per unit of R&D per unit of sales) sat at 0.95, more than 10x of the pharma sector’s 0.08. This stellar catch up of biotechnology is also visible in pharmaceutical valuations, since in 2014 biotechnology companies accounted for roughly 40% of drug company valuations for a historic high. In terms of multiples, namely enterprise value to pre R&D operating income, the biotech sector’s premium has noticeably dropped over the pharma sector. It sat at a high of ~77x in 2000 and dropped to ~18x in 2014 for a markedly lower premium over the pharma sector’s ~11x which had sat at 20x in 2000.
Building on this, while the market level valuations of pharma companies have shifted over the years due to the growth in biotechnology companies, this does not provide us with any details about what drives firm level valuations. On this front, research that used ten year data from 101 firms demonstrates that the three key drivers of pharma valuation are R&D, advertisement, and production facilities. These three have regression derived valuation weights of 13.19, 15.85, and 19.13, respectively. This provides key insights as it suggests that R&D is far from being the key competitive edge in the industry as is commonly believed.
In fact, advertising and production are key drives for pharma valuations when we consider the biggest thorn in the industry’s side, namely patents. 2024 has seen weight loss drugs cement their place in the market, and as their patents start to expire, the industry and the government could enter more thorny fights that could impact pharma valuations. The industry’s detractors accuse pharma firms of unsavory practices such as filing ancillary patents that extend patent lifetimes by filing patents for different features of the same product, filing differently worded yet similar patents in what is called building patent thickets, and purposefully delaying upgrades to benefit from evergreening provisions.
While it might seem that this potential disruption to the pharma sector is far off in the future, the reality is different. This is because GLP-1 based weight loss drugs, liraglutide, albiglutide, and dulaglutide, were first approved by the FDA in the 2010s and firms in India and China have already started working on making cheap biosimilars that could attract a wider market. Things are moving fast even in the developed world as the Indian firm Biocon has already secured approval for a liraglutide generic in the UK while the FTC sent letters to ten companies, including some of the biggest weight loss companies, in May as part of its bid to fight bogus patents. Looking forward, you should expect the number of generics to rise and patent fights to intensify since the weight loss pie could be as big as $100 billion by 2030 according to a well known investment bank.
With these details in mind, let’s take a look at the top cheap pharma stocks that have seen mercy from short sellers.
A closeup of pills in a pharmacy, representing the high quality medications of the company.
Our Methodology
For our list of best pharma stocks to buy according to short sellers, we ranked specialty and general drug manufacturers with a market cap greater than $300 million by the percentage of shares outstanding that were sold short and selected the stocks with the lowest percentage. Then, those stocks with a trailing P/E ratio lower than 57.63 or a current P/E ratio lower than 38.94 were chosen. These are the sector averages for the pharma industry.
For these stocks, we also mentioned the number of hedge fund investors. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
10. Johnson & Johnson (NYSE:JNJ)
Short Interest as % of Shares Outstanding: 0.78%
Number of Hedge Fund Investors In Q2 2024: 80
Johnson & Johnson (NYSE:JNJ) is one of the biggest pharmaceutical companies in the world. 2024 has been a very important year for the firm as it has agreed to pay a whopping $700 million to settle lawsuits surrounding its talcum powder. The impact of the payout will be evident on Johnson & Johnson (NYSE:JNJ)’s balance sheet for years to come, and the firm also secured a major relief in August when sources reported that it had received the adequate number of votes to declare bankruptcy as part of the $6.4 billion in talcum powder lawsuits that it is facing. On the product front, Johnson & Johnson (NYSE:JNJ) is expected to lose exclusivity of its arthritis drug called Stelara in 2025 which could create revenue headwinds as the product has generated as much as $9 billion in revenue for the firm in the past, Additionally, it is also focusing on its growing medical devices business and expanded its presence in the market through an August acquisition of a heart device maker.
Johnson & Johnson (NYSE:JNJ)’s is quite focused on the MedTech business as evidenced during the Q2 2024 earnings call:
“Turning to MedTech, we continue to advance our pipeline, launch new commercial products and integrate strategic acquisitions that broaden and further differentiate our portfolio. In cardiovascular, we are enhancing our portfolio and shifting into higher growth markets through strategic acquisitions such as Shockwave Medical. In May, we announced the launch of our CARTO 3 Version 8 electroanatomical mapping system. This is the latest version of our 3D heart mapping system, which has machine learning capabilities that increase efficiency, reproducibility, and accuracy in maps electrophysiologists use to treat atrial fibrillation and other arrhythmias. In pulsed field ablation, we initiated the commercial launch of the VARIPULSE platform in the EU and Japan receiving early positive physician feedback in the external evaluation period.
We also delivered results from the pivotal phase of the admIRE trial, where the VARIPULSE platform demonstrated 85% peak primary effectiveness with minimal adverse events, short PFA application times and low fluoroscopy exposure. In orthopedics, we received 510(k) FDA clearance for the clinical application of the VELYS Robotic-Assisted Solution in unicompartmental knee arthroplasty. This is designed for both medial and lateral procedures enabling surgeons to guide precise implant placement without a CT scan. In surgery, we launched the ECHELON 3000 in the U.S., which combines 3D stapling and gripping surface technology to enable greater staple line security. This has been shown to deliver 47% fewer leaks, reduce surgical risks and improve surgical outcomes.”
9. GSK plc (NYSE:GSK)
Short Interest as % of Shares Outstanding: 0.60%
Number of Hedge Fund Investors In Q2 2024: 36
GSK plc (NYSE:GSK) is a British pharmaceutical giant headquartered in Brentford. Its global presence and diversified product portfolio which covers vaccines, specialty, and generic medicines means that the firm can profit from all stages and kinds of the pharma chain and products. GSK plc (NYSE:GSK)hefty resources, as evidenced by its GBP4.9 billion in cash and equivalents means that the firm can keep the pedal on the metal when it comes to drug development. As of now, the firm has 70 new drugs under development in its pipeline, which include seven drugs in phase three testing. Through these, GSK plc (NYSE:GSK) has big plans for its future, as it is aiming for GBP38 billion in sales in 2031. Focusing on the present, three of the firm’s top selling products are Menveo and Bexsero which are meningitides treatments and Shingris, which is a treatment for herpes. Other fast growing drugs include a lead disease treatment called Nucala and HIV medicine called Cavenuva.
GSK plc (NYSE:GSK)’s management provided key details for fast growing HIV portfolio – a major catalyst – during the Q2 2024 earnings call:
“Our oral 2-drug regimens and long-acting injectables continue to transform the HIV marketplace. Dovato delivered sales of £551 million in the quarter. The strong body of clinical data and real-world evidence reinforcing the efficacy and durability of this medicine continues to grow. At the International AIDS conference last week, results of the PASO DOBLE study a large head-to-head randomized clinical trial of Dovato compared against the 3-drug regimen, Biktarvy, showed non-inferior efficacy and significantly less weight gain.
This is important because we know people living with HIV are concerned about taking more medicines as they age as well as the long-term risk of metabolic diseases that can come with weight gain. Our long-acting portfolio also continues to perform strongly, delivering more than 50% of total HIV growth. Cabenuva grew 42%, driven by patient preference and proven and durable efficacy. CASM LATITUDE data presented at CROI and data from real-world cohorts that include over 10,000 people living with HIV in diverse settings has resonated strongly with physicians and has supported increased breadth and depth of prescribing. Apretude grew more than 100% in the quarter. This medicine has demonstrated proven superior efficacy compared with daily orals and a positive safety profile and high patient preference.
As a reminder, the registrational HPTN 084 study of PrEP in women was the first to show 0 infections in participants who received injections as described per protocol. We believe that long-acting therapies are the future of HIV care, empowering people impacted by HIV with choice and addressing the barriers standing in the way of reaching the end of the HIV epidemic. Looking at the long-acting market, we can see that the treatment market is currently approximately 10x larger than the PrEP market at about £20 billion, which will have a significant impact on the sales potential for long-acting options. In the long-acting inject for treatment setting, there are no competitor launches planned before 2028. We continue to see strong progress across our pipeline.”
