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Pharmaceutical share prices

What are the rules governing pharmaceutical share prices? We explore the murky world of the stock market, explain how share prices are determined and find out what makes City analysts tick.

Private eyeLike any other shares, the factors governing pharmaceutical share of prices reflect the collective opinions of hundreds, if not thousands, of investors. These investors range from fund managers, dealers and institutional investment managers to private investors. A share price reflects, in a number of pence, investor opinion on how a particular company will fare in the future.

As opinions constantly change, so does the share price. Opinions are culled from a company's recent performance, the perceived quality of the management, assessing a run of that company's accounts and comment in the media. In the case of professional investors, key ratios such as operating profits to sales, debt to equity and debtors to creditors, will be sifted through and compared with other companies in the same industry or sector.

A topsy-turvy market
The stock market often appears highly irrational. A pharma company may post excellent profits but the company's share price takes a tumble. Another pharma firm may announce a nasty loss but the share price rises sharply.

This irrationality is due to the market's time-honoured habit of overdoing things. Even though the pharma company may have posted excellent profits, a large number of professional investors may have been expecting the firm to do even better. Equally, investors may have been expecting a much greater loss - and the share price rises as investors pile in to place orders.

Good and bad news can have a dramatic effect on prices. For example, Irish drug company Elan saw its shares slump 56 per cent after the death of a second patient was linked to its multiple sclerosis drug, Tysabri, which was recently withdrawn.

Calculating share price
There are two approaches to pricing shares. One is by calculating the net asset value per share - which can be above or below the market share price. In the case of a giant pharma company, net asset value per share will usually be greatly below the market price as there will be much greater importance attached to past profitability and how many potential blockbuster drugs are in the R&D pipeline.

The other approach to pricing a share is to look at the profits accruing to the company under the microscope and to estimate how much they may rise. That essential tool, the 'price/earnings' ratio, comes into its own - the ratio reflects how many years' future earnings per share you are buying at the market price of the share.

Professional investors like pharma companies as long as the latter can charge high prices for their drugs and shield their products from cheap generic competition by tight patent protection. Currently, the pharma sector is in the City's bad books as the City believes that the world's pharma companies are not generating enough new drugs.

The key area determining share prices among pharma companies lies in how well new drugs are coming through the pipeline. In this respect, the pharmaceutical and biotech sector differ from other sectors. If a company's R&D department develops a potential blockbuster drug and the product passes all the regulatory hurdles, it can be launched on to a highly lucrative worldwide market.

Cash availability is another key criteria. Recently, shares in Phytopharm fell 20 per cent after Japanese partner, Yamanouchi, indicated that it might return the rights to Alzheimer's drug Cogane following its merger with Fujisawa. Phytopharm was forced to abandon a £24m fundraising to develop the drug ­- causing worries about its cash levels.

Conversely, the loss of such a market on patent expiry can prove catastrophic as it opens up the floodgates of generic competition. Recently, shares in GlaxoSmithKline (GSK) fell 4 per cent as US regulators stopped trials of GSK's multiple sclerosis drug 683-699 following a safety scare. The product belongs to the same class of drugs as Elan's multiple sclerosis drug Tysabri.

The news in March that US marshals had seized supplies of GSK's controlled-release antidepressant, Paxil CR, and diabetes drug, Avandamet, following manufacturing problems affected GSK's share price. US regulator, the US Food and Drug Administration, said that the drugs failed to meet safety standards.

Analysts at Nomura cut full-year revenue forecasts for Paxil CR from £885m to £555m forecasting that it would now give way to generic competition. Skyepharma supplies the slow-release formulation for Paxil CR and City analysts worry that GSK's problems could hit both companies' profits in the short term.

Political shockwaves
There are also political developments that have to be priced into a pharma's share price. For example, Medicare, the US health insurance scheme which accounts for 40 per cent of the world's biggest drug market, is forecast by Wood Mackenzie to slash some drug prices by an average of 10 per cent. Some cuts could be even bigger - cancer drug Taxol had an average price last year of $138 but will have a Medicare price of only $18.

Medicare health insurance managers will only have to give patients a choice of two products in each drug class. This means branded drugs such as GSK's anti-depressant Paxil will compete with generic copy-cat drugs. Both AstraZeneca and GlaxoSmithKline are among the 17 companies that will be hit by Medicare changes and this information will be factored into their share prices.

No one can predict the future, but the stock market tries to do its best as the collective wisdom of thousands of investors percolates down into a single pharma share price, which may last only a second.

The Author
Malcolm Craig is the editor of Stockmarket Confidential and a leading investment commentator in the UK.

2nd September 2008

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