How to Trade the New Health Care Reform Bill

03/26/2010 12:01 am EST

Focus: ETFS

Now that the historic health care bill has been signed into law by President Obama, drug makers are likely to reap all the benefits, and for good reason.

The overhaul of the health care system will likely add to the revenues of big pharmaceutical companies. From a mere quantity perspective, the reform is expected to provide insurance coverage to more individuals, hence giving more people the ability to pay for prescription medication, which will push sales volumes up significantly.

From a competition perspective, it appears that the pharmaceutical sector has won nearly a decade of protection against generic-like competition for biotech drugs.  Additionally, the law does not contain any measure that bars the sector from paying generic drug makers to delay the launch of less-expensive alternatives. In essence, cash heavy pharmaceutical firms have the ability to pay off more cost effective competitors who manufacture “knock-off” alternatives and control the prescription drug market.

Another potential victory can be seen through the scrub of measures that could have potentially eaten away at revenues generated from drug sales to the elderly.  More specifically, the law does not include any measures that would enable the government to dictate and negotiate the price of drugs sold through Medicare Part D, which for some pharmaceutical companies, can comprise nearly 25% of all revenues.

Lastly, the new piece of legislation is anticipated to close the gap in Medicare drug coverage known as the “doughnut hole,” which forces elderly patients to pay for prescription drugs through the implementation of a discount program.  This concession is expected to benefit pharmaceutical companies by enticing elderly users to stay around as opposed to ceasing their medicine or switching to lower-price generics due to cost constraints and affordability.

With this in mind, some equities likely to be influenced by the law include:

  • PowerShares Dynamic Pharmaceuticals (PJP), which boasts biopharmaceutical giants Merck (MRK) and Gilead Sciences (GILD)
  • iShares Dow Jones US Pharmaceuticals (IHE), which holds pharmaceutical giants Pfizer Inc. (PZE) and Johnson & Johnson (JNJ) as top holdings, two companies that are especially likely to reap the benefits of this new law
  • SPDR S&P Pharmaceuticals (XPH), which holds diversified health care companies like ViroPharma Inc. (VPHM) and Perrigo Company (PRGO)

Although a rosy picture lies ahead for the sector, it is important to consider the inherent risks involved with investing in equities. A good way to mitigate these risks is through the implementation of an exit strategy that triggers price points at which an upward trend could potentially be coming to an end.

Kevin Grewal, editor, www.SmartStops.net

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