ETFinnovators (< 20)

Are Drug ETFs a Rx for Profits?

October 10, 2008 – Comments (0) | RELATED TICKERS: PJP , IHE , PPH

The top four holdings in the Pharma HOLDRs (PPH) account for over 60% of the 21 components and include Johnson & Johnson (JNJ – 25.8%), Pfizer (PFE – 15.6%), Abbott Labs (ABT – 11.8%), and Merck (MRK – 10%). However, this is by far the most popular pharmaceutical exchange-traded fund [ETF] with net assets of $1.7 billion and an average daily trading volume of over 800,000 shares and it carries the lowest price-to-earnings [PE] multiple (12.5).

PowerShares Dynamic Pharma (PJP) takes a more balanced approach with a total of 30 component stocks, as its top 10 holdings are weighted in a range of 3.2% to 5.5% (JNJ). This is the top performer among the three pharmaceutical ETFs, which is trading at a PE of just under 15 and a 0.6% yield.

iShares Dow Jones US Pharma (IHE) takes the middle road between the former two with its top five holdings accounting for just over one-third of the total assets, including JNJ – 8.5%, PFE – 7.4%, MRK – 6.8%, ABT – 6.5%, and Wyeth Labs (WYE – 6.2%) among a total of 38 component stocks. This ETF recorded the second best performance of the group with a PE of 13.2 and a 1.1% yield.

I would favor the latter two ETFs as a way to invest in the US pharmaceutical market, as Pharma HOLDRs is too leveraged to a small number of individual stocks which could simply be purchased on their own rather than buying PPH. In addition, the 11% decline in MRK on Tuesday due to negative results in a clinical study of the cholesterol drug Vytorin.

Among the remaining two drug ETFs, my favorite pick would be PJP, as I prefer the total number of holdings (30) and mix of companies included in the ETF. For example, the top holding in PJP is Genentech and it also holds other established biotech companies such as Amgen (AMGN), Gilead (GILD), and Biogen (BIIB). PJP also offers a healthy mix of generics such as Perrigo (PRGO), Watson Pharma (WPI), and recently-acquired Barr Pharma (BRL). Overall, the mix of traditional brand pharma, generic, biotech, and specialty pharma companies makes PJP my favorite choice for a diversified investment in US-based drug companies.