EXECUTIVE SUMMARY
The Pharmaceutical (Pharma) industry has long been a significant engine of the global economy. Throughout the 1990s, Pharma industry valuations were high due to expected industry growth, robust profitability, and overall optimism about scientific advancements. However, by the turn of the millennium, positive sentiment was decreasing in light of tougher FDA approval standards, health care cost scrutiny, and reduced research and development (R&D) productivity. By 2009, valuations plummeted to historically low levels as investors appeared to be questioning the viability of the traditional “Large Pharma” business model.
Through our bottom-up research process, we started to build conviction that this out-of-favor industry was going through a difficult cycle as opposed to a terminal decline. We performed extensive due diligence and identified several Pharma companies that we believed were undervalued. By 2012, we had accumulated a significant overweight position in the industry across the Dodge & Cox equity funds.(a)
While we reduced the Funds’ relative weightings recently in light of higher valuations, they remain overweight the industry compared to their respective benchmarks. Looking ahead, we believe the Funds’ Pharma holdings stand to benefit from three key investment drivers—increased R&D productivity, growth opportunities in emerging markets, and durable business franchises—over our three- to five-year investment horizon. At current valuations, we remain enthusiastic long-term shareholders of companies in this industry.
In 2013, worldwide spending on prescription drugs exceeded $717 billion, with the top 10 best-selling drugs accounting for $75 billion. The Pharma industry is an important driver of the global economy, and we believe we have identified several companies within this industry that are particularly attractive investment opportunities over our investment horizon. We will discuss: 1) the investment process we used to establish overweight positions in the Pharma industry across the Dodge & Cox equity funds; 2) the pillars of our current Pharma investment thesis, and; 3) our valuation framework for analyzing such companies.
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