3 Drug Stocks With Some of the Highest Profit Margins

By Sean Williams Markets Fool.com

Investors have an absolute smorgasbord of choices when it comes to the biotech and pharmaceutical industries. There are, in total, well over 300 publicly traded drugmakers to consider investing in.

Continue Reading Below

Of course, many of those drugmakers (somewhere near 90%) are also losing money. The drug development process isn't set up for a high degree of success -- and rightly so. The Food and Drug Administration wants to ensure that only high-quality, safe, and effective drugs make it to pharmacy shelves. This means the success rate from discovery to pharmacy shelf is exceptionally low, which makes our task in finding investable drug stocks quite challenging.

Image source: Getty Images.

Thankfully, stock screeners can help us out a bit. After running a screen for profitable drug stocks with market caps of at least $300 million and a profit margin in excess of 20%, a little more than a dozen companies emerged. I've chosen to focus on profit margin because it can highlight a number of factors that biotech and pharma investors usually appreciate, such as strong pricing power and prudent spending.

Today we'll take a brief look at some of the highest profit margin drug stocks based on their trailing 12-month data.

Taro Pharmaceutical Industries Ltd.

Continue Reading Below

Near the top of the pack among drug stocks is Israeli-based Taro Pharmaceutical Industries (NYSE: TARO) with a trailing 12-month profit margin of 51.5%! Taro is a hybrid drug developer in that it's primarily reliant on its generic and over-the-counter pipeline of roughly 200 drugs, though it does have branded therapies that are sold under generic names.

Typically, generic drugmakers have pretty low overhead costs since they don't have to spend years and hundreds of millions of dollars running clinical trials, which is a challenge that often plagues branded-drug developers. Instead, Taro is counting on volume to drive its top- and bottom-line. In this respect, Taro should be successful over the long-term. Considering that branded drug prices are soaring in the United States, the push toward more affordable generic medicines is only bound to increase. This could drive up the demand for Taro's generic medicines, as well as its pricing power.

Image source: Getty Images.

Having high margins also means reasonably strong cash flow generation. According to the company's third-quarter earnings release, it netted $320.5 million in operating cash flow through the first nine months of its fiscal year, which is a nearly $81 million year-over-year improvement. Thus, it's probably no shock that Taro's board of directors approved a $250 million share repurchase agreement in November. Buying back stock can lower the number of shares outstanding and increase a company's EPS, making it appear more attractive on a fundamental basis.

Is Taro the perfect stock based on its leading profit margin? Not exactly. Net sales hit a pretty rough patch in Q3 with a nearly 15% decline, although they're only down 0.4% through Q3. Nonetheless, its 50%+ profit margin is certainly a figure that should get Taro on investors' radars for a closer inspection.

United Therapeutics Corporation

Specialty drugmaker United Therapeutics (NASDAQ: UTHR) is another mid-cap stock with a juicy profit margin -- 44.6% over the trailing 12-month period, to be exact.

With the exception of neuroblastoma drug Unituxin, which only comprised $62.5 million of the company's $1.6 billion in sales last year, United Therapeutics' entire portfolio derives its revenue from four products designed to treat pulmonary arterial hypertension (PAH). PAH is a disease characterized by high blood pressure in the arteries between the heart and lungs.

The great news for United Therapeutics is that specialty drug prices have been rising at a breakneck pace over the past couple of years, giving it exceptional pricing power and dwarfing its production and research and development costs. It also doesn't hurt that sales and marketing costs have been falling, which is a response to its PAH drugs gaining more rapport with physicians.

Image source: Getty Images.

However, unlike Taro Pharmaceutical above, United Therapeutics may be facing some challenging times ahead. For example, Swiss-based Actelion was already serious PAH competition, but the recent launch of Uptravi, combined with Johnson & Johnsonagreeing to buy Actelion in a $30 billion deal, could push United Therapeutics to look at things from a business development angle (mergers and acquisitions) in order to grow its top-line. Between the expected entrance of generics in the future and tougher competition from J&J, United Therapeutics' top-line could fall in the years to come.

The advantage of its exceptionally high profit margin is that it may be able to repurchase its own stock or initiate a dividend without any worry, but it still doesn't resolve the company's intermediate-term growth concerns. United Therapeutics is a company worth watching based on its superior cash flow, but I'd suggest sticking to the sidelines until it brings new products into its portfolio and pipeline, and preferably until it diversifies beyond PAH.

Gilead Sciences, Inc.

Finally, biotech giant Gilead Sciences (NASDAQ: GILD) comes in with a mouthwatering profit margin of 44.4% over the trailing 12-month period. Though Gilead may have a few revenue nibbles in other indications, the bulk of its sales are derived from its trio of hepatitis C products and its complement of HIV medications.

Gilead made headlines in late 2013 and again in 2014 when Sovaldi and then Harvoni were approved by the Food and Drug Administration to treat hepatitis C. These were oral, once-daily products, and, in Harvoni's case, eliminated the need for IV interferon or ribavirin, both of which were known to cause a number of unpleasant side effects in patients. In 2015, when Gilead was able to hit all of the low-hanging fruit (i.e., the in-dire-need patients in the U.S.), it racked up more than $20 billion in HCV sales alone.

Image source: Getty Images.

Things are a bit tougher for Gilead now. New once-daily oral competition has entered the field, which has coerced the company to increase its gross-to-net discounting to insurers. In 2017, HCV products are only expected to account for $7.5 billion to $9 billion in sales.

On the other hand, Gilead's HIV product portfolio is on fire. Genvoya generated nearly $1.5 billion in sales during its first full year on pharmacy shelves, while Stribild topped $1.9 billion. The launches of Odefsey and Descovy have also gone well, with both products pacing about $600 million in annual sales based on their Q4 sales figure, though they are likely on track for much more in 2017. Gilead's HIV pipeline continues to pump out growth for the company.

Though Gilead is clearly facing challenges because of its success in hepatitis C, its incredible cash flow, inexpensive valuation, and 3% yield make it an attractive drug stock to consider buying.

Find out why Gilead Sciences is one of the 10 best stocks to buy now

Motley Fool co-founders Tom and David Gardner have spent more than a decade beating the market. (In fact, the newsletter they run, Motley Fool Stock Advisor, has tripled the market!*)

Tom and David just revealed their ten top stock picks for investors to buy right now. Gilead Sciences is on the list -- but there are nine others you may be overlooking.

Click here to get access to the full list!

*Stock Advisor returns as of February 6, 2017

Sean Williams has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Gilead Sciences and Johnson and Johnson. The Motley Fool has a disclosure policy.