3 Best Stocks for Investing in Generic Drugs

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Americans spent more on prescription drugs last year than ever before -- nearly $374 billion, according to IMS Health. That figure reflected a 13.1% jump over 2013 spending. Health insurers and government payers certainly don't like that trend and are pushing patients to use generic drugs whenever possible. And they will continue to do so for years to come.

Generic-drug makers stand to benefit from this dynamic, as do smart investors who buy shares of the stocks most likely to win in the generic-drug market. Which stocks fit the bill? Here are three of the best stocks poised to profit on the boom in generic drugs.

1.Actavis plc Actavis is the third-largest generic drugmaker in the U.S. The companymarkets around 250 generic drug product families in the U.S. Its prominent generic products include Lidocaine, the first generic equivalent for local anesthetic drug Lidoderm, and Telmisartan, a generic version of blood pressure drug Micardis.

Source: Actavis

Mergers and acquisitions have been the name of the game for Actavis -- and the company is playing the game well. Shares are up nearly 600% over the past five years, and Actavis doesn't appear to be losing steam.

Allergan became Actavis' latest conquest in March. The $70.5 billion deal launched Actavis into the world's top 10 largest pharmaceutical companies in terms of revenue. This acquisition also positions the company for continued strong growth and adds blockbuster branded products to its roster, including Botox and Linzess. Analysts expect average annual earnings growth of more than 17% over the next five years.

All of this activity led to a net loss of $1.27 billion in 2014. However, on a non-GAAP basis factoring out acquisition-related items, Actavis generated earnings of $3.11 billion. Those results were enough to drive shares up more than 50% over the past 12 months.

Actavis claims a forward earnings multiple of less than 14. I wouldn't say this is a value stock, but the growth potential at a reasonable valuation makes Actavis one for investors to seriously consider.

2. Akorn As great as Actavis' stock performance has been, specialty generic-drug maker Akorn has looked even better. Shares rocketed nearly 3,000% over the past five years and are up almost 47% year to date.

Source: Akorn.

Akorn has also been busy picking up other businesses. It bought Hi-Tech Pharmacal in April 2014. Akorn acquired privately held Excelvision AG in July and quickly followed up by buying VersaPharm in August.

Thanks largely to these acquisitions, Akorn projects 2015 revenue to grow at least 47% and earnings to jump by 62% compared with last year. And those results from last year were quite solid, with revenue topping $600 million and adjusted earnings per share more than doubling from 2013.

Akorn's product lineup includes around 170 generic drugs in addition to 12 branded drugs. Among these products are Clobetasol Propionate, a corticosteriod used in treating skin conditions, andProgesterone, which is used to prevent endometrial hyperplasia. Akorn recently launched its latest promising generic,Phenylephrine HCl, a solution used to dilate pupils. The company also markets generic and branded drugs for animals.

While the company's trailing-12-month price-to-earnings ratio of 159 is in nosebleed territory, Akorn's growth prospects give it a forward P/E of a much less scary 22. I wouldn't be surprised if a larger player ultimately gobbles up Akorn.

3.Mallinckrodt plc Covidien spun off Mallinckrodt in 2013, a move that has proven to look pretty good in hindsight. Mallinckrodt's stock is up 180% since then, with shares doubling over the past 12 months.

Source: Mallinckrodt

Like many other generic-drug makers, Mallinckrodt hasn't been immune to buyout fever. Mallinckrodt bought Cadence Pharmaceuticals in early 2014 for $1.4 billion. Later in the year, it picked up Questcor Pharmaceuticals for $5.8 billion. More recently, Mallinckrodt acquiredIkaria for $2.3 billion.

Mallinckrodt's generic business unit claims around 30% market shareof DEA Schedules II and III opioid and oral solid dose medications. The company specializes in generic drugs like these that involve tight regulations. Its ability to navigate the regulatory hurdles stands as a real competitive advantage.

While Mallinckrodt is a major player in the generic-drug market, though, its deal-making has turned the company into more of a branded specialty pharmaceutical player. Last quarter, generics contributed net sales of $284.2 million. Branded specialty drugs, however, combined for $373.6 million in net sales -- led by Questcor's Acthar with sales of $266.4 million.

Mallinckrodt's forward earnings multiple currently stands at 13.6, reflecting strong growth projections for 2015. Acthar should continue to drive growth, but the company's specialty generics, especiallyoxycodone-related products, should also play a key role.

One wrinkleThere is one wrinkle to keep in mind with Actavis, Akorn, and Mallinckrodt. Each company carries plenty of debt as a result of all the acquisition activity.

Actavis has total debt of over $15.5 billion, whileMallinckrodt's debt level stands at $3.97 billion. However, both companies claim debt-to-equity ratios that aren't too concerning. Akorn's debt is lower at $1.12 billion, but it has a debt-to-equity ratio of 2.9 -- a level that can raise eyebrows.

Despite the debt loads, I still think all three of these stocks should be winners over the next several years. Generics will remain a hot commodity -- and these stocks should, too.

The article 3 Best Stocks for Investing in Generic Drugs originally appeared on Fool.com.

Keith Speights has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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