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Drugs that slay cancer and neutralize ALS are tantalizingly close, to hear the media tell it. But while potential therapies earn lots of ink, the hype is often premature and the letdown devastating. Still, some exciting new treatments are winning the FDA’s approval. Weight-reducing injectables and medications designed to slow down Alzheimer’s are acing trials and shipping to pharmacy shelves, firing investors’ imaginations in the process.

The pharma stars of the moment

On the weight-loss front, Novo Nordisk (NVO) was first out of the gate with Wegovy. Endorsed by celebrities like Elon Musk, it’s a reprocessed version of Ozempic, the pharma’s diabetes medication. Now Eli Lilly (LLY) and Amgen (AMGN) are preparing launches of their own anti-obesity products.

Meanwhile, FDA just approved the use of the Alzheimer’s-slowing substance Leqembi, a creation of the Japanese company Eisai (ESAIY) and the American firm Biogen (BIIB). And Lilly has another promising Alzheimer’s treatment waiting for a nod from the FDA. Its drug, donanemab, is also said to decelerate cognitive decline.

Cue the fanfare. After all, the obesity rate among U.S. adults, at 42 percent, has reached epidemic proportions, turbocharging diabetes rates, heart ailments and other health issues. In addition, some 6.7 million Americans 65 or older suffer from the shattering effects of Alzheimer’s. So it’s inevitable that companies producing these medications have caught the eye of investors.

Now, speculators are looking at other firms with discoveries in the wings for hints about where next to place their bets. We’ll get there, but first, a look at the industry as a whole.

The big picture on big pharma

Drug firms have typically been good picks for investors. Their sales resist the ebb and flow of the economy because health is not a luxury. Consider: In 2019, U.S. doctors prescribed an astonishing one billion drugs to their patients. It’s not surprising, then, that in 2022—as COVID peaked and receded—annual global revenue for the pharma market reached $1.48 trillion, with American firms accounting for more than half. That’s led to robust operating profits—on average double those of the market in general. As a result, stockholders in these companies have generally enjoyed healthy returns.

Assessing the negatives

Investing in pharma is not a slam dunk, however. The major firms sink about 20 percent of their sales revenue into R&D, but desirable outcomes are elusive. Think needles and haystacks. Typically, scientists find one good lead among the 5,000 to10,000 compounds they investigate. Even then, development, trials and the approval process of new treatment candidates can take as long as 15 years.

What’s more, proprietary drugs normally hit a patent cliff after two decades, at which point cheaper, generic versions become available. That means sales evaporate rapidly for the company that made the original product. Counterfeits also eat into profits.

Then there’s the matter of legal liability when things go wrong. Johnson & Johnson (JNJ) grabbed headlines when it had to fork out billions for its role in helping fuel the opioid crisis. Pfizer (PFE), Abbott (ABT) and others have been hit with megabuck fines too. Cyberattacks pose a new threat to the industry, as well. In a 2020 study, IBM (IBM) reported that hackers cost the sector more than $5 million.

Risk—and the siren call of ETFs

One way to mitigate the risk is by investing in a basket of stocks through an exchange traded fund, or ETF. Bankrate, for example, recommends iShares US Pharmaceuticals ETF (IHE), which had a 10-year annualized return of over 10 percent. Other funds garnering attention are VanEck Pharmaceutical ETF (PPH) and Invesco Dynamic Pharmaceuticals ETF (PJP).

For the brave at heart looking to invest in individual companies beyond the recent stars, here are just a few considerations.

• Does a firm with expiring patents have promising drugs in the pipeline? One example is AbbVie (ABBV) which is losing exclusive rights to the formula behind Humira, its top-selling rheumatoid arthritis drug. At the same time, it’s getting close to producing treatments for Parkinson’s, blood cancer and some 20 other conditions.
• Is the enterprise developing drugs for an aging population? Here are two among several candidates in this category. Apellis (APLS) is working on drops to help prevent blindness in the elderly. Meanwhile, GSK (GSK) has a vaccine in the offing said to combat respiratory syncytial virus (RSV), a disease that can be deadly in older adults.
• How likely is FDA approval? Despite successful late-stage trials, the regulatory body may still have questions about the safety of a treatment or other concerns. Without FDA approval, a drug is dead in the water.

Pharmaceutical stocks are appealing, with many big names repeatedly posting profit margins of 20-plus percent. But to keep their powder dry, wise investors will want to make sure that there’s real substance behind new drug promises.