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Big Pharma stocks have been soaring the last 12 months. Pfizer (NYSE:PFE), for instance, has gained close to 35%, Merck (NYSE:MRK) 25%, and Lilly (NYSE:LLY) 40% for instance, compared to a 14% gain for the S&P 500 (NYSEARCA:SPY).

What is fueling these gains?

Three things: First, record low interest rates that make defensive stocks paying good dividends like Big Pharma an irresistible proposition.

Second, favorable demographics. Big Pharma rides the soaring demand for medicine, fueled by the massive 'aging out' of baby boomers, which began around 2005 as the first boomer cohort crossed the age of 60. This trend is expected to last until 2024, when the last cohort crosses the age of 65. The portion of the world's population that's over 60 is expected to reach 30% by 2025, compared to 20% in 2000.

Third, Big Pharma has a strong pipeline of new products, some of which have already gained FDA approval. Pfizer and Bristol-Myers Squibb (NYSE:BMY), for instance, announced positive results on their blood thinner drug; Abbott (NYSE:ABT) reported positive results for a Hepatitis C Regimen; and Lilly reported positive results for its Metastatic Gastric Cancer drug, as well as its new Alzheimer's drug.

Big Pharma financial performance statistics in 2012:

Company

Bristol-Meyers Squibb

Pfizer

Lilly

Merck

SPY

Dividend

3.4%

3.1%

3.40%

3.5%

2.03%

Operating Margin

26.54

32.54

28.89

22.60

--

Quarterly Earnings Growth

8.6

--

-3.6

-40.0

--

Quarterly Revenue Growth

-23.30

--

-1.)

-4.5

--

Source: Finance.yahoo.com

I particularly like Bristol-Myers Squibb, which reported earnings in line with analyst expectations this morning, as it strives to cope with two setbacks in recent years. The first setback came from the prospect of the expiration of one of its blockbuster anti-platelet drugs, Plavix, in 2012. The second came from proposed budgetary cuts for Medicaid and Medicare. Yet the stock is trading near its five-year high.

I believe it is a buy, for three reasons:

  1. Strong financials, especially operating margins.

  2. A strong pipeline of new products, some of which have already gained FDA approval, like Eliquis, Metaglip, and Sprycel.

  3. A string of acquisitions that help the company rebuild its pipeline. Last Saturday, the company paid $5.3 billion for Amylin Pharmaceuticals, the maker of two diabetes drugs, while last February, it acquired Inhibitex.

A Few Words of Caution: Investors should be warned, however, that Big Pharma is facing two headwinds that may derail the recent rally. First, a strong product pipeline doesn't guarantee that these products will get FDA approval. Second, the oligopolistic nature of the healthcare industry, which has the power to dictate drug prices, and even drop coverage, as was the case with Questcor Pharmaceuticals (NASDAQ:QCOR) last year.

The bottom line: Most of the bad news is behind for Big Pharma stocks. And with the Fed deciding to keep interest rates at record low levels, they offer an attractive alternative to money markets and CDs. Hype, however, shouldn't be a substitute for due diligence.

Source: The 3 Drivers Behind The Big Pharma Rally