Jim Cramer Urging Investors to Sell Pharmaceutical Stocks

Once upon a time in a galaxy far away, pharmaceutical stocks were once considered an integral part of a diversified portfolio. Investors were urged to add pharmaceutical stocks to their portfolios due to their defensive nature. Now Jim Cramer is urging investors to sell pharmaceutical stocks calling the sector “just one expensive graveyard.”

 

Merck

Merck [[MRK]] started the year with a lot of potential. They had several drugs in late stage trials and were our upset pick to be the top dividend stock for 2011. However, by mid-January the company was forced to halt their phase III trials for their promising cardiovascular drug, vorapaxar. As a result, Merck shares are down 8% since the beginning of the year and are underperforming the Dow Jones index.

 

Expiring Patents

It’s fairly easy to identify the issue that is plaguing the pharmaceutical industry – expiring patents. This year $15 billion worth of pharmaceutical drugs will lose their patent protection. That has the potential to heavily dent the profitability of major pharmaceutical stocks.

 

Here is a look at the potential earnings impact of these expiring patents on the major pharma players:

 

Bristol-Myers Squibb – 39% decline in profits

 

Eli Lilly – 34% decline in profits

 

Pfizer – 20% decline in profits

 

Merck – 12% decline in profits

 

All of these major pharmaceutical stocks offer hefty dividend yields. Pfizer is lowest yielding stock among them and they still offer a 3.8% dividend yield. Unfortunately, those big dividend payments may not last forever. Already the dividend increases are getting smaller. Last December, Bristol-Myers Squibb gave investors a small dividend increase of only a $.01 per share. Next year the news gets even worse as the pharmaceutical industry has $36 billion in drugs that will lose their patent protection.

 

Declining R&D Spending

With so many valuable patents expiring over the next few years, you would think that the big pharma companies would be investing heavily to develop the next set of blockbuster drugs. However, the exact opposite has been happening.

 

In order to shore up their profits, pharmaceutical stocks have been slashing their research and development budgets. GlaxoSmithKline [[GSK]] is cutting their R&D spending by a third. Eli Lilly [[LLY]] is reducing their R&D spending by 24%.

 

With a product pipeline that is eerily empty, the pharmaceutical industry is left with few options. Many companies are trying to increase prices, while others are trying to acquire growth. Despite the wave of blockbuster M&A deals over the last couple of years, more industry consolidation is probably still to come.

 

Pharmaceutical stocks are no longer a defensive holding in your portfolio and even their attractive dividend yields may become at risk in the coming years. That has led Jim Cramer to urge investors to sell their pharmaceutical stocks before they decline further in value.

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