“Never invest in any idea you can’t illustrate with a crayon.”
Those words were spoken by the famed investor Peter Lynch.
It’s a wonderful rule, and one that all investors should endeavour to stick to. If you want to invest in a bank, but don’t know what a loan impairment charge is, then for now avoid the banking sector.
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But keep in mind that at some point you will need to step out of your comfort zone. A portfolio needs balance: if you only invest in what you understand, and subsequently the whole sector faces headwinds, your entire portfolio will go down.
We can insure ourselves against this by investing in a range of companies across different sectors.
Why invest in pharma?
At first glance the pharmaceutical industry might seem intimidating to approach. Sticking to our earlier-stated mandate, could you draw a lymph node, or any other organ of the immune system, with a crayon? (Now in truthfulness, I couldn’t, either. And nor can I even pronounce half the jargon.)
But that’s to disregard what Lynch actually meant, of course.
The idea behind investing in pharmaceutical shares is their merits as defensives. Irrespective of the state of the economy, or the margin of England’s latest defeat in the World Cup, a defensive company will continue to perform strongly.
That’s because the products sold by pharma companies — such as AstraZeneca’s (LSE: AZN) (NYSE: AZN.US) Nexium, which treats acid-related diseases, or GlaxoSmithKline’s Advair, a respiratory medication — are products we need all the time.
Big revenue gains
At around £44, shares in AstraZeneca are well above their £30 low last July, and the yield (based on last year’s earnings) is a handsome 4.1%.
Earlier this year AstraZeneca posted a pre-tax loss of $715m (£420m) from a profit of $2bn (£1.2bn) in 2013. The late-stage drug pipeline, however, has nearly doubled since a year earlier, so despite flat sales anticipated for the next two years, AstraZeneca is forecasting “strong and consistent” revenue gains of 75% in the next decade, driven by new cancer, diabetes and heart disease treatments.
Analysts have flagged the $45bn annual sales target — a defensive salvo against Pfizer‘s recent £69.3bn takeover bid — as being overly optimistic. If you get out a calculator, however, sales growth from $26bn to $45bn requires a 6% compound growth per annum to meet targets.
Does that sound fantastical? Hardly. The dividend (and share price), therefore, should rise congruent with earnings increasing.
