19th June 2024 by Akshay Sharma | Pharmaceutical
The biopharmaceutical sector is currently navigating a dynamic and challenging landscape, as highlighted by Gronde et al. (2017). This scenario is characterized by increasingly stringent regulations in the pharmaceutical and healthcare sectors, a substantial rise in development costs for pharmaceutical compounds, and a growing emphasis on identifying new, value-based payment models. Simultaneously, many governments are grappling with the task of maintaining a delicate balance between health and social expenditures to ensure sustainability.
Against this backdrop, discussions surrounding prices and profits within the biopharmaceutical industry have gained momentum in social discourse, as noted by McCarthy (2015), Kesselheim et al. (2016), and Sibbald (2017). It is our contention that relying solely on industry profitability for drawing conclusions may be misleading for two primary reasons. Firstly, assessing return on investment is crucial, as elevated profits do not necessarily equate to substantial investor returns. Secondly, considering the inherent risks associated with investment and business activities, evaluating return on investment necessitates a comprehensive understanding of the risks faced by industry participants and investors. Despite this, there is currently limited knowledge about the risks and returns specifically associated with the biopharmaceutical industry.
Our study aims to fill this knowledge gap by investigating whether the risk-adjusted return on investment in the biopharmaceutical industry surpasses that of other industries. In pursuit of this objective, we systematically measure both risks and returns within the biopharmaceutical sector, compare these metrics with analogous industries engaged in the development of innovative products, and assess the level of risk-adjusted return on investment for the biopharmaceutical industry in comparison to these alternative sectors.
Analyzing Profitability and Risk-Adjusted Returns in the Biopharmaceutical Industry: A Comparative Study with Benchmark Sectors, the profitability of the biopharmaceutical industry has been a focal point in societal discussions. However, relying solely on industry profitability for conclusions is inadequate, as it overlooks the crucial element of investor risk. This study seeks to assess both risks and returns in the biopharmaceutical sector, specifically investigating whether the risk-adjusted return on investment in this industry surpasses that of others. To facilitate a meaningful comparison, we identified six benchmark industries sharing characteristics with the biopharmaceutical sector: automotive manufacturing, commercial aircraft manufacturing, consumer electronics, packaged food manufacturing, telecom, and oil and gas.
For each industry, we selected the top 25 companies, covering a substantial percentage of industry revenues (35–65%). Utilizing data from Bloomberg spanning the period from 2004 to 2016, we derived return measures (net profit margin, return on equity, total shareholder return) and risk measures (volatility of total shareholder return, beta). The Sharpe ratio was calculated as a key indicator of risk-adjusted return on investment and compared across industries. Notable findings include varying net profit margins in the biopharmaceutical industry (12.6–19.5%), contrasting with benchmark industries (2.6–8.4%). Return on equity in the biopharmaceutical industry exceeded the average for other sectors, while total shareholder returns ranked fifth among the seven industries at 11.7%. The biopharmaceutical industry ranked sixth in both beta and volatility of total shareholder return. The median Sharpe value placed the biopharmaceutical industry fifth among the seven sectors. Over the 2004–2016 period, our analysis reveals that the biopharmaceutical industry did not achieve risk-adjusted return on investment superior to that of other industries, thus failing to outperform its counterparts.
The biopharmaceutical industry has demonstrated notable outperformance in terms of net profit margins compared to benchmark sectors. While standard return measures, such as return on equity, also positioned the biopharmaceutical industry above the average for benchmark sectors, a nuanced picture emerged when examining total shareholder returns. Investors in the biopharmaceutical industry did not experience returns that surpassed those in other industries.
Our analysis delved into the industry's unique characteristics, revealing that the biopharmaceutical sector leads in research and development (R&D) spending as a percentage of gross margin and sales. However, higher business and operational risks were identified, as evidenced by larger intra-industry dispersion of net profit margins and volatility over time. Factors contributing to this elevated risk include prolonged product development timelines, complex and fragmented regulations, shorter periods of patent protection, and increased competitiveness compared to other industries.
Surprisingly, data on volatility of total shareholder return and beta indicated that risks faced by investors in the biopharmaceutical industry were not significantly higher than those in benchmark industries. This suggests that, while specific risks exist, investors do not receive commensurate returns for accepting them, as these risks can be diversified by forming portfolios of uncorrelated assets. Moreover, the industry's structure, benefiting from patent protection, market exclusivity, and premium pricing for innovative medicines, serves as a mitigating factor.
The study employed the Sharpe ratio to link investor risks to returns, revealing that total risk-adjusted returns for the biopharmaceutical industry closely aligned with the average of benchmark industries over the past 12 years. This implies that investors in the biopharmaceutical sector did not realize risk-adjusted returns surpassing those in comparable industries during this period.
While previous studies have examined risk-return measures within and across industries, our analysis uniquely compared the entire biopharmaceutical industry with various sectors, going beyond the scope of contrasting pharmaceutical and biotechnology companies. Additionally, our study did not limit its scope to publicly traded U.S. biopharmaceutical companies, broadening the applicability of findings.
However, our study has limitations, including the 12-year historical period and the selection of six benchmark industries. Extending the study to a longer period or a larger set of industries could provide additional insights, but such choices require careful consideration of relevance, changes in company composition over time, and potential biases. Accounting standards and the treatment of R&D spending also present challenges, and the study did not differentiate between sub-sectors within the biopharmaceutical industry due to data constraints.
Selection of Comparable Industries and Data Methodology in Assessing the Biopharmaceutical Industry, to ensure a meaningful comparison, benchmark industries were selected based on specific characteristics mirroring the biopharmaceutical industry. These characteristics encompassed the marketing of quantifiable, tangible products or services, the level of research and development (R&D) investment, industry maturity, and the degree of market concentration. Six industries were identified as comparable: automotive manufacturing, commercial aircraft manufacturing, consumer electronics, packaged food manufacturing, telecom, and oil and gas. The top 25 companies per industry, covering 35–65% of industry revenues, were chosen for analysis. Data for the study were sourced from Bloomberg, providing a clear and replicable dataset. Key variables included sales, operating and net profit margin, R&D costs, equity, capital employed, stock prices, and betas. Return measures focused on the net profit margin, a standard indicator of profit generation. Additionally, the study utilized the return on equity metric, which integrates net profit margin, asset turnover, and financial leverage. Total shareholder return, encompassing both dividends and investment appreciation, was also considered. In response to the ongoing debate regarding industry R&D spending, the study compared R&D expenses as a percentage of gross margin and sales across the selected industries.
Risk measures were differentiated between business/operational risk faced by industry participants and risks encountered by investors. Business/operational risk was assessed through year-on-year changes in net profit margins and the inter-quartile range, reflecting the dispersion of net profit margins within an industry. Investor risks were highlighted through commonly used measures such as the volatility of total shareholder return and beta, representing the correlation of specific investment returns with market returns. The Sharpe ratio, a widely accepted metric for risk-adjusted return on investment, was employed. Calculated as the excess total shareholder return over the risk-free rate divided by the stock’s volatility, the Sharpe ratio offered insights into the industry's performance considering the level of market risk. The study covered a 12-year historical period from 2004 to 2016, providing a comprehensive analysis that captured industry trends across various economic cycles, both upward and downward. This extended time horizon aimed to offer a nuanced understanding of the biopharmaceutical industry's dynamics over a significant timeframe.
Financial Performance and Risk Assessment of the Biopharmaceutical Industry: A Comprehensive Analysis, Net profit margins in the biopharmaceutical industry exhibited fluctuations around a median level of 16.8%, peaking at 19.5% in 2009 and hitting a low of 12.6% in 2014. In stark contrast, net profit margins for benchmark industries ranged from 2.6% to 8.4%. Return indicators, including asset turnover and financial leverage, presented distinct patterns. The biopharmaceutical industry maintained a stable asset turnover at 53%, consistently lower than benchmark industries (excluding the telecom sector). However, its financial leverage ratio of two ranked as the lowest among the benchmark industries. Combining these metrics into the return on equity placed the biopharmaceutical industry among the highest, surpassing returns in aircraft and parts manufacturing and packaged food manufacturing.
Total shareholder returns for the biopharmaceutical industry over the 2004–2016 period amounted to 11.7%, ranking fifth among the seven industries studied. Research and development expenses as a percentage of gross margin reached 21%, aligning with the automotive industry and surpassing other benchmark industries. Reinvesting 16% of sales into R&D, the biopharmaceutical industry stood out as the most R&D-intensive, with the consumer electronics sector following at 5%.
In terms of business/operational risk, the biopharmaceutical industry exhibited double the volatility in net profit margins compared to benchmark industries, with a median standard deviation of 9.3%. It also demonstrated the highest intra-industry dispersion of net profit margins, with an inter-quartile range of 12.5%, surpassing benchmark industries.
Assessing risks faced by investors, the biopharmaceutical industry ranked sixth in volatility of total shareholder return and beta among the seven industries. The median Sharpe ratio, a measure of risk-adjusted performance, placed the biopharmaceutical industry fifth out of the seven industries from 2004 to 2016. This comprehensive analysis provides insights into the financial dynamics and risk profiles of the biopharmaceutical industry, shedding light on its relative performance within the broader economic landscape.
In summary, the analysis of the biopharmaceutical industry, in comparison to benchmark sectors, reveals a complex financial landscape. The industry showcased consistent net profit margins around 16.8%, with notable fluctuations between 2009 (peak at 19.5%) and 2014 (low at 12.6%). In contrast, benchmark industries exhibited a more varied range of net profit margins. Return indicators, including asset turnover and financial leverage, presented a distinctive picture. While the biopharmaceutical industry maintained a stable asset turnover below benchmark sectors, its financial leverage ratio ranked as the lowest among the industries studied. However, the combination of these metrics into the return on equity positioned the biopharmaceutical industry among the highest performers, surpassing certain benchmark sectors. Total shareholder returns for the biopharmaceutical industry over the 2004–2016 period ranked fifth among the seven industries. The industry's commitment to research and development (R&D) was evident, with expenditures constituting 21% of gross margin, outpacing other benchmark industries. This commitment is further emphasized by reinvesting 16% of sales into R&D, marking the biopharmaceutical sector as the most R&D-intensive.
Analyzing business/operational risk revealed higher volatility in net profit margins for the biopharmaceutical industry compared to benchmark sectors. The industry also displayed the highest intra-industry dispersion of net profit margins, indicating a higher level of variability.
Investor risks, assessed through measures like volatility of total shareholder return and beta, positioned the biopharmaceutical industry sixth among the seven industries. The median Sharpe ratio, a key indicator of risk-adjusted performance, placed the biopharmaceutical industry fifth over the studied period.
In conclusion, the biopharmaceutical industry's financial performance is characterized by consistent net profit margins, substantial R&D investments, and competitive returns on equity. However, the industry faces higher business/operational risk, reflected in volatile net profit margins and intra-industry dispersion. Investors in the biopharmaceutical sector do not experience significantly higher risks compared to other industries, but risk-adjusted returns do not surpass those in certain benchmark sectors. The industry's commitment to innovation, coupled with inherent operational challenges, shapes its financial dynamics within the broader economic context.