How to Invest in Pharmaceutical Stocks the Easy Way

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Healthcare stocks performed extremely strongly in 2017, rising more than 20% and providing much of the lift that the overall stock market saw last year. Among healthcare companies, many of those that focus on traditional pharmaceuticals lagged behind other parts of the healthcare sector, such as managed care. But going forward, many investors are optimistic that pharma stocks will catch up or even surpass the performance of other healthcare companies.

You can buy individual pharmaceutical stocks, but the danger there is that if you pick the wrong one, you could miss out on big gains if another company's candidate drug turns out to be the newest industry blockbuster. Instead, choosing exchange-traded funds (ETFs) that focus on pharma stocks can be an easier way to profit from the space. You'll find several pharma ETFs to help you get the exposure you want.

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Top pharma stock ETFs

2 ways to get broad-based pharma exposure

ETF industry leaders iShares and SPDR make regular appearances on lists of top funds, and their presence in the pharma space isn't surprising. What's interesting is that their ETFs take a much different angle on pharma stock investing. The iShares ETF takes a traditional approach, owning more than 40 stocks and weighting them according to market capitalization. That puts the industry's biggest players front and center within the portfolio, with the top holding commanding almost 10% of the ETF's assets.

Yet the SPDR chooses to track a modified equal-weight index that limits maximum exposure of any individual stock to about 4.5%. That potentially gives the smaller companies in the SPDR ETF's portfolio a greater opportunity to contribute to its performance. As you can see above, though, the SPDR's performance is only a bit better than what the corresponding iShares fund achieved during the period.

Taking a more active role

The other ETFs in the pharma space make efforts to choose what they see as the most promising stocks in the sector. The PowerShares fund uses its Intellidex proprietary methodology to identify and rank stocks based on factors like value, quality, management actions, and momentum in the company's earnings growth and stock price. More importantly for the fund's performance recently, the PowerShares ETF also includes some names that you'd traditionally think of as being biotech stocks. That's one reason why the fund has outperformed its peers even with a higher expense ratio of 0.56%.

Similarly, the VanEck ETF goes a bit further afield by including shares of drug distribution companies within its purview. It also includes international stocks in the sector, some of which have performed better over the past year than their U.S. peers. With an expense ratio of 0.40%, the VanEck fund tracks a more concentrated index of 25 stocks that encompasses not only pharmaceutical research and development but also production, marketing, and sales.

Make money from pharma stocks

Broad-based healthcare stock exposure is easy to find, but among some of the industry's leaders, the strongest growth prospects have been concentrated within the pharmaceutical realm. By drilling down specifically on healthcare stocks that have substantial exposure to the pharmaceutical industry, you'll be in a better position to take maximum advantage of that superior growth over the long run. With returns having lagged recently, now's a particularly good time to look more closely at pharma stocks and the ETFs that specialize in them.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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