Pharmaceutical Stocks: Dividends, the Patent Cliff and How to Invest in the Sector

Pfizer earned tens of billions of dollars on the pandemic. Then 2023 came and vaccine revenues vanished as quickly as they had appeared — and with them the share price. Pharmaceutical companies know this well. One successful drug can generate the biggest profit of a decade. One expired patent can erase a third of revenues overnight. Yet the pharmaceutical sector is a long-time favourite destination for investors seeking defensive income. Why? And when does it make sense?

Why pharma attracts investors

The pharmaceutical sector offers a combination that is hard to find elsewhere: defensive character — people buy drugs in recession and boom alike — and solid dividends. AbbVie, the maker of Humira, is counted among the so-called dividend aristocrats and has long paid a yield significantly above the market average. Novartis and Roche are Swiss giants with internationally diversified revenue streams and a stable dividend history exceeding twenty years. Pfizer is the best-known American player with enormous research capacity — its pipeline includes dozens of candidates across various therapeutic areas.

Add to this high barriers to entry: the FDA or EMA approval process takes years and costs billions. A typical new drug development from first synthesis to approval takes ten to fifteen years and costs billions of CZK. That gives established players a competitive advantage that is otherwise difficult to build. Health is also a structural theme — the ageing population in developed countries guarantees growing demand regardless of the economic cycle.

The dividend character of the sector is specifically interesting for Czech investors. Major pharmaceutical companies traditionally pay 40–60% of earnings in dividends and regularly increase the dividend. For investors with an accumulation strategy, however: distributing funds or direct shares bring dividends on which tax must be paid. With UCITS accumulating ETFs this obligation disappears — the fund reinvests automatically and the tax obligation arises only on sale.

The patent cliff: the biggest threat nobody talks about enough

Pharmaceutical companies live from patents. A patent typically lasts 20 years from filing — but a large part of that time passes in the laboratory or clinical testing, so the real market window is usually 10–12 years. Then the patent expires and the so-called patent cliff arrives.

Once generic versions enter the market, the drug's price typically falls 70–90% within two years. A company that built its income statement on a single blockbuster feels this brutally. AbbVie faced exactly this scenario with Humira — the world's best-selling drug — when US patents expired and biosimilar competition began pressuring market share. The company responded with extensive diversification into oncology and immunology through the Allergan acquisition and development of next-generation immunomodulators.

Roche and Novartis have built more diversified pipelines and a stronger presence in biologically more complex drugs, where generic substitution is harder — so-called biosimilars require a more extensive approval process and manufacturing know-how. That gives them slightly greater protection. Roche also has a diagnostics division accounting for approximately a third of revenues, which does not depend on patent exclusivity in the same way as drugs.

Research pipeline: betting on the future

The value of a pharmaceutical company rests not only on today's products — to a significant extent it reflects what is in research and development. The pipeline is a collection of drug candidates in various phases of clinical trials. Phase I tests safety in healthy volunteers, Phase II checks efficacy in a smaller group of patients, Phase III compares against existing treatment or placebo in large groups in extensive randomised studies. Failure in Phase III can knock a share price down by tens of percent overnight — even if the company otherwise looks entirely healthy.

The success rate statistics are sober: approximately 90% of candidate substances entering clinical testing never reach approval. Of those entering Phase I, approximately 10–15% reach final approval. Oncology has an even lower success rate. For an investor who does not want to read clinical protocols, this means one thing: betting on a single pharmaceutical company is a concentrated bet on the outcome of scientific research.

ETFs as a sensible route into the sector

For most investors it makes sense to enter pharma through a diversified fund rather than selecting individual names. There are several paths:

• Broad health care ETF — includes pharmaceuticals, biotechnology, medical devices and care providers. Pharma typically accounts for 40–60% of such a fund.
• Pure pharmaceutical ETF — these exist, but the selection of UCITS variants for European investors is narrower. Check the composition: if the top five holdings account for more than 50% of the fund, you effectively have a concentrated portfolio.
• Broad-market ETF — healthcare including pharma accounts for approximately 12–14% in the MSCI World index. If this exposure suffices without overweighting, you don't need a sector fund at all.

When selecting a UCITS ETF, check the Irish domicile, which is advantageous from the perspective of dividend taxation for a Czech investor, and prefer the accumulating variant that automatically reinvests dividends — for pharmaceutical ETFs with higher yields this makes a tangible difference over a long horizon thanks to the power of compound interest. Also check TER: pharmaceutical and health care ETFs typically range from 0.20–0.45%, with cheaper variants tracking standard MSCI Health Care indices.

Cyclicality, defensive character and the Czech tax dimension

Pharma is labelled a defensive sector — and this holds to a considerable extent. In recessions, people don't stop taking medications for diabetes, cancer or high blood pressure. Revenues are more stable than in cyclical sectors like energy or basic materials.

But watch out: defensive doesn't mean uneventful. Regulatory risks are real — drug price regulation in the US or EU can dramatically affect margins. And biotech names, which in some funds mix with classic pharma, are the opposite — very volatile. Binary clinical trial outcomes can cause 30–50% moves overnight.

From a Czech investor perspective, don't forget the three-year holding test. If you sell a pharmaceutical ETF or shares after three years, the gain is exempt from income tax — provided total annual sales don't exceed the statutory limit. Dividends will still be taxed regardless of holding period, so for distributing funds this advantage doesn't apply to dividend income. The accumulating fund variant elegantly solves this — dividends never physically arrive, they are continuously reinvested.