When it comes to healthcare stocks, there is a huge difference in earnings stability and consistency between pharmaceutical companies and healthcare equipment/devices providers. In the case of the former, earnings are likely to be far more volatile, as they depend upon new drugs constantly being developed to replace those going off patent, while for the latter there is much more consistency due to relatively stable demand for products and a slower changing industry.
This difference is evidenced by the bottom lines of pharmaceutical company, AstraZeneca (LSE: AZN) (NYSE: AZN.US), and healthcare equipment/devices provider, Smith & Nephew (LSE: SN) (NYSE: SNN.US). For example, during the last five years AstraZeneca has seen its earnings decline by an incredible 33%, as it has been unable to replace a number of key, blockbuster drugs that have lost their patent protection. Meanwhile, Smith & Nephew has delivered earnings growth in four of the last five years, with its net profit being 26% higher in 2014 than it was in 2009.
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Of course, AstraZeneca is due to return to growth in 2017 and, as a result of an aggressive acquisition programme, has a pipeline that looks set to offer a purple patch over the medium term. However, in the next two years it is expected to post a fall in earnings of 6%, as further sales falls are anticipated. This contrasts markedly with Smith & Nephew, which is expected to see its bottom line flat line this year, before growing by an impressive 13% next year.
However, AstraZeneca’s near term potential seems to be much more appealing than pharmaceutical peer, Indivior (LSE: INDV). Sales for its main drug, suboxone, are falling due to a loss of patent protection and the company is expected to see its bottom line fall by 59% this year and by a further 21% next year. Certainly, it has the potential to deliver other drugs and has an impressive pipeline, but investor sentiment could shift downwards unless it makes progress in this regard during the next couple of years.
The main downside of buying Smith & Nephew is its valuation. It currently trades on a price to earnings (P/E) ratio of 21 which, despite its greater stability and consistency, lacks appeal when you consider that AstraZeneca has a P/E ratio of 17.2. And, with Indivior’s P/E ratio set to rise to 16 next year, it may offer better value than AstraZeneca but has a less diverse pipeline and higher risk future.
Therefore, AstraZeneca seems to offer the best mix of risk and reward of the three companies, with it occupying a middle ground in terms of having long term growth potential via its upbeat pipeline, but also offering diversity so as to reduce the risk of further challenges moving forward.