By: Chelsea Pratt
With the pharmaceutical industry projected to grow by billions in the coming years, penny stocks are an inexpensive way for investors to enter an active market.
Compared to large cap pharmaceutical stocks, these securities are higher risk—but also carry the potential for greater returns.
What are pharmaceutical penny stocks?
Pharmaceutical penny stocks are securities issued by small, early-stage companies that research, develop and manufacture new drugs through chemical or plant synthesis.
These companies are modest in terms of revenue or employee size, and their market capitalization is also small: a ‘microcap’ penny stock has a market capitalization below $300 million, while a ‘nanocap’ penny stock’s market cap is less than $50 million.
Since these companies often do not meet the listing standards set out by the major market exchanges, their securities tend to be traded over-the-counter—and relatively cheaply. In fact, penny stocks are so-named because of their low price: investors can purchase a large volume at minimal expense, typically less than five dollars per share.
Pharmaceutical penny stocks vs large cap stocks
Large cap stocks, by contrast, have a market capitalization over five billion dollars. Subject to more rigorous reporting and listing standards, they are traded on the major market exchanges.
The pharmaceutical sector is dominated by several large cap stock companies, including Pfizer (NYSE:PFE), Johnson & Johnson (NYSE:JNJ) and Novartis (NYSE:NVS). Generally, these large cap stocks are considered safer investments, as their size provides a buffer: company setbacks are not as strongly felt by the individual investor.
Pharma is an attractive sector because of its projected growth. This year’s life sciences report from Deloitte anticipates global pharma spending to reach US$1.4 trillion in 2019, an average annual increase of 4.3 percent each year.
Those numbers are based on increased consumer demand. As people live to an older age, there is a greater call for new and better medications. Likewise, sedentary lifestyles and unhealthy habits have increased the occurrence of chronic illness. Add in a resurgence of old diseases, like pertussis or tuberculosis, and the reasoning behind pharma’s projected growth becomes clear.
With their low buy-in cost, pharmaceutical penny stocks can be an attractive, accessible way for investors to enter this market. They also offer higher possible returns than large cap securities. The potential for explosive growth means investing early can pay off big.
Of course, it can also lead to great losses.
The American biopharmaceutical sector invests more money in research and development (R&D) than any other industry, according to PHRMA’s 2015 report—and they do it without any guaranteed returns. Only two of every 10 marketed drugs are profitable and clinical failure rates are high at every phase of testing.
This uncertainty makes investing in pharmaceutical companies seem like a high risk venture. But with large cap pharmaceutical stocks, investors are somewhat insulated from that risk, thanks to several factors Investing News Network outlines here.
Smaller pharma companies, on the other hand, are less able to weather clinical trial failures. Since they have fewer product lines than bigger pharmaceutical enterprises, it is more difficult to offset expenses lost in failed R&D. These early-stage companies are also more vulnerable to “me-too” drugs, or medications that treat the same disease in a different way.
Bottom line? Losses can be big should a company’s product prove less popular than its competition’s, or if that product fails to meet endpoints in clinical trials.
Further, fraud is a real risk with pharmaceutical penny stocks, as it is with all securities traded over-the-counter. Minimal disclosure rules make it difficult for investors to gauge the success of a company or its product. When choosing pharmaceutical penny stocks, therefore, investors may wish to opt for those traded on the major exchanges, which are subject to the same strict listing requirements as more mature companies.
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Securities Disclosure: I, Chelsea Pratt, hold no direct investment interest in any company mentioned in this article.