Answering the question, "Does a Drug Approval Mean a Higher Stock Price?" is fairly straight forward, but there are some caveats that investors need to be aware of. The simple answer is yes, in most cases a new drug approval can lead to a higher share price for the company on the receiving end of that approval. However, each company and approval need to be considered individually so investors can avoid drug approval disappointment.
What Is The Approved Drug?
The word "blockbuster" is often used in association with new drug approvals and history has shown that is exactly what a company needs to have approved to ensure its shares skyrocket post-approval. Examples of potential blockbuster drugs would include, but are not limited to, treatments for cancer, diabetes and sexually transmitted diseases. Another way of looking at this situation is this. A pharmaceutical company has just received approval to sell a new treatment for common allergy symptoms. While that drug may eventually prove to be an important part of the company's revenue stream, it is used to treat a mundane condition and unlikely to really jolt the company's shares.
What Company Is Getting The Approval?
In some cases, the company on the receiving end of a new drug approval is almost as important as what drug is being approved. In this case, before approval, investors should evaluate the potential impact of the new drug on the company's top and bottom lines. For example, there have been examples of small biotechnology companies that, because of funding constraints, only work on one or two major treatments at a given time. Financial markets are aware of this and when those companies land drug approvals, the shares usually surge. On the other hand, an established, large-cap pharmaceuticals company can land a new drug approval, but if that drug is only expected to account for a small percentage of profit and revenue, the approval is unlikely to do much for the share price.
Who Is Doing The Approving?
When it comes to regulatory bodies that affect a drug company's share price, none exceed the importance of the U.S. Food and Drug Administration. Arguably, the only entity that comes remotely close is the European Union's equivalent of the FDA. That is to say a company may get its new blockbuster drug approved in Brazil, but that alone is unlikely to have a significant impact on the shares. The company's investors will want to see the drug approved in the U.S. or Europe, preferably both, for maximum reward on their investment.
Many new blockbuster drugs, particularly those that treat cancer or genetic diseases, are expensive. Related to the issue of pure cost is whether or not health insurance providers will help their patients make up the difference in purchasing expensive new drugs. Bottom line: If a new drug is ultra-expensive to the point that it cannot be accessed by patients and insurance providers are reluctant to absorb the cost, the manufacturer is not going to sell much of that drug and that is not good for the share price.
Todd Shriber is a financial writer who started covering financial markets in 2000. He worked for three years with Bloomberg News and specializes in analysis of stocks, sectors and exchange-traded funds. Shriber has a Bachelor of Science in broadcast journalism from Texas Christian University.