Home Forum Political Economy Beating the hell ouf of the average

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  • #245759

    Judging by profit margins, the most powerful firms in the S&P500 are pharmaceuticals.

    In their 2020 study, ‘Profitability of Large Pharmaceutical Companies Compared With Other Large Public Companies‘ (JAMA 323, 9, March 3, pp. 834-843), Ledley et al. show that, during the period 2000-2018, the top 35 pharmaceutical firms in the S&P500 outperform virtually every other group (with a possible exception of “technology”).

    They had higher gross profit margins, higher EBITDA margins and higher net margins. They also did better than non-pharmaceutical health care firms.

    This is one of their charts:



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    • #245760
      Scot Griffin
      • Topics started: 5
      • Total posts: 41

      But did that profitability result in differential capitalization compared to other S&P 500 companies?

      Health insurance provider United Health Care (UNH) may not have been as profitable as pharmaceutical companies, but its share price grew much more (>13x) over the same period (2000-2018), at least compared to the two largest market cap pharma companies today:

      UNH v Johnson & Johnson and Psizer

      Here is a link to a comparison between UNH and the top 5 pharma companies from 2000 until today. UNH’s share price has grown 6000% compared to Roche’s 425% (the largest increase of the 5) in the same period. The S&P500 grew only 188% over the same period.

      FYI – it is my understanding that health insurance companies, like all insurance companies, are judged by a different set of metrics than product companies, as insurance companies don’t do anything other than try to maximize the percentage of premiums they keep as profits. Also, regardless of the rate of inflation, healthcare costs go up by 7% a year in the US because the health insurers and providers negotiate annual price increases and lock them in a year in advance. UNH is fine with annual growth, as long as it retains its 15% of premiums as profits.


      • #245762
        Jonathan Nitzan
        • Topics started: 17
        • Total posts: 98

        But did that profitability result in differential capitalization compared to other S&P 500 companies?

        I don’t know the answer to this question with respect to pharmaceuticals and the S&P500 in the U.S., but I can say something about the global scene.

        The figure below is part of my current work-in-progress with Shimshon on the pharmaceutical companies.

        The chart shows the distributive share of listed pharmaceutical firms in the net profit and market capitalization of all listed firms in the world (as provided by Datastream).

        The data suggest that, over the past half century:

        (1) both shares have trended upward;

        (2) their long-term movements have been positively correlated; and

        (3) generally, the pharmaceutical share of market capitalization has been greater than its net profit share.

        So, on the face of it, there is basis to think that (1) differential profit growth has driven differential market capitalization growth, and (2) investors expect differential profit growth to accelerate (hence the larger PE ratios implied by the relationship between the two differential indices in the chart).

        • #245770
          max gr
          • Topics started: 3
          • Total posts: 12

          Thanks for this, Yoni. A few follow up questions:

          1. Is the pharma PE ratio actually rising in absolute terms? I’m not sure if it’s directly evident from the graph.

          2. Is the PE ratio rising diferentially (compared to the global PE)?

          3. If it is, why assume it has to do with differential expected profits and not with differential risk reduction?

        • #245771
          Jonathan Nitzan
          • Topics started: 17
          • Total posts: 98


          1. Both PE ratios — for the pharma sector and for the world — have trended mildly upward over the period.

          2. The long-term trend of the ratio of PE ratios (pharma PE / World PE) has been virtually flat at roughly 1.5 (eye balling).

          3. You are correct: the positive ratio of PE ratios implies expectations for differential profit growth and/or differential risk reduction. In our ongoing research, we show that this is what happened historically: the pharma sector outperformed on both counts.

    • #245776
      Jonathan Nitzan
      • Topics started: 17
      • Total posts: 98

      Here is a brief research note summarizing our argument on the capitalist outlook:

      Bichler, Shimshon, and Jonathan Nitzan. 2021. Pharmaceuticals: Beating the Hell Out of the Average. Research Note (June): 1-5.

      More to come.

      • #245796
        Jonathan Nitzan
        • Topics started: 17
        • Total posts: 98

        Regarding the ‘free-cash-flow’ argument made in the third footnote of our piece.

        To reiterate, the claim against Figure 2 in our research note is that (1) capitalists discount not net earnings, but the free cash flow; and (2) that, in the case of pharmaceutical firms, the relative magnitude of the free cash flow (compared to the average) is higher than the relative magnitude of net earnings (compared to the average).

        If the relative magnitudes of the free cash flow and of market capitalization are the same, it follows that capitalists see the future growth of pharmaceutical free cash flow and/or risk as being the same as the average.

        But that is not what the data indicate.

        Instead, they show that:

        1. In terms of magnitudes, the relative shares of market capitalization > net earnings > free cash flow.

        2. In terms of trends, the slopes of market capitalization > net earnings > free cash flow.


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