Big Pharma Spells Big Profits For You

Jul.30.12 | About: Johnson & (JNJ)

Big pharma companies have had a nice run so far this year.

All you have to do is take a look at the chart below, comparing the performance of major pharma companies to the performance of the S&P 500.

Chart foriShares Dow Jones US Pharmaceuticals (<a href=

The red line represents the S&P 500 while the lines in blue and green represent 2 ETFs: the IShares Dow Jones U.S Pharmaceuticals (IHE) and the SPDR S&P Pharmaceuticals (XPH), respectively*. This one year chart shows a clear winner.

The big picture

There are 2 main factors attributed to the overwhelming performance of this somewhat sleepy sector of big pharma.

The first is the probable implementation of Obamacare. This could lead to millions of new paying customers being added to the health care system. The major players in the field will be the first ones to benefit from this trend.

The second is the element of uncertainty that currently prevails in the markets. Big pharma companies pay big dividends and are mostly regarded as 'safe plays'. As such, they are more appealing to fund managers in today's turbulent times.

The trade

There is one company that stands out from its peers in the index. It has been trending sideways for almost a decade and is currently on the verge of an imminent breakout.

This company is the famous Johnson & Johnson (JNJ). The trading range for the shares over the past year has been $59.08 to $69.70. This is also the same share range since 2005, with a single exception of the 2008 crisis.

On July 17th, the company reported its 2Q report for 2012. The company has reported net earnings of $1.4BL from sales of $16.5BL. It maintains an impressive operating margin of 25%.

JNJ currently trades for $69.52 (as of the close on Friday) We are nearing a possible multi-year breakout.

JNJ is in good company

It is important to mention that JNJ is not the only big- pharma about to break new highs. One other example is Bristol Myers (BMY) which is nearing its 52 week high of $36.34 despite the fact that on July 25th, the company reported a decrease of 18% in sales year-over-year and a decrease of 27% in diluted earnings per share.

Another example from the same family is Novartis (NVS) which is also nearing its 52 week high despite the fact that on July 19th, the company reported a drop of 7% in earnings per share year-over-year.

It seems that money managers have fallen in love with pharma stocks. We will try and benefit from this trend. Of all stocks, the best bet would be JNJ.

Trading instructions

Before we enter a breakout trade, we must wait for a breakout confirmation. Hence, we will buy JNJ shares upon crossing the $69.82 (30 cents higher than the previous ultimate high). We will take profit at $77 and place our stop loss at $66.14 which is the most recent line of resistance.

* You can review the full list of Pharma ETFs in an article by a colleague SA contributor, David Fry.

Disclosure: I am long JNJ.