Wall Street has traditionally held drug stocks in high esteem because of their outstanding growth-and-defensive characteristics—a rare combination of two ordinarily conflicting qualities.

The growth status of drug companies comes from their heavy emphasis on research as the launching pad for endless new products. On the other hand, their defensive qualities are based on the virtually recession-proof or even depression-proof nature of their products, since nobody can avoid buying necessary drugs even in times of depression.

In the recession year of 1958, for instance, Wall Street regarded practically all pharmaceutical shares as special situations. They appeared regularly on the "new highs" list. Most of them reached record price levels. This, however, was not surprising, since drugs were the only major industry whose earnings actually gained in that recession year.

In 1959, profits of the drug makers failed to keep up with the advanced market level of their shares, especially in comparison with equities of other growth industries, which made better progress in earnings, though selling at lower price-earnings multiples.

The situation worsened in 1960. In the second quarter of that year, for instance, ten leading drug companies reported a decline of 7.4 per cent in earnings over the corresponding period of 1959, though sales were generally slightly ahead of 1959 levels. This trend of falling profits continued in the third quarter of 1960.

As a result, investors began to cast doubt on drugs as a growth industry. Moreover, Kefauver's Senate antitrust investigations put the drug industry in a bad light. The industry was said to have made undue profits at the expense of the public. The cost of many drugs was said to be only a fraction of the price when sold in the drugstore. Many drugs, especially the "wonder" drugs, were said to be obtainable abroad at considerably lower prices than those charged by domestic makers.

Typical was the charge made by John Blair, the Senate subcommittee's

economist, that Bristol Laboratories (a division of Bristol-Meyer Co.) produced tetracycline for $5.03 per 100 tablets, while the druggist paid $30.60. That kind of publicity possesses an inherent appeal for the public, especially at a time of ever-rising medical and drug expenses. People had little interest in the answer of Philip I. Bowman, president of Bristol Laboratories, who said that price included only production costs, not costs for research or promotion.

There is no denying that the profit margin of drug makers has been traditionally higher than that of most other industries. Testifying before the Senate subcommittee, W. G. Malcolm, president of American Cyanamid, said the company set a profit goal of 15 per cent on sales after taxes which, though twice the average profit margin of American industries, was said to be moderate in view of drug makers' heavy costs.

As a percentage of sales, the drug industry probably spends more on research than any other established industry. Research expenditures reached 9 per cent of sales in 1959 against only 4.6 per cent of volume as recently as 1955. That was proportionately twice as much as chemistry (another research-minded industry) was spending or four times the 2.2 per cent of America's average industry.

Nor was this heavy research outlay always fruitful. Lederle Laboratories (a division of American Cyanamid), for example, spent about $13 million to turn out an oral polio vaccine that was rejected by the U.S. Public Health Service. It was revealed and generally agreed at the Kefauver committee hearings that drug research was a gamble at best—the average chance of commercial applications being about 1 in 2,500. Even successful drugs tend to be short-lived.

This is true even of the so-called breakthrough products. When a major product is successfully introduced, the initial profit to the discoverer firm is, of course, enormous. But profits tend to decrease as competitors enter the field.

If new products were a hallmark of growth, then the growth record of drug makers is indeed impressive. Within the past two decades, they have introduced such major products lines as antibiotics, antihistamines, synthetic hormones, amino acids, radio-isotopes, tranquilizers, energizers, diuretics (for heart disease), polio and other antiviral vaccines. It has been estimated that seven out of every ten prescriptions filled today could not have been filled in 1935. That's certainly growth, in the most literal sense.

In terms of measurable contributions, drug makers are believed to have been largely responsible for adding, over the past two decades, nearly ten years to the average American's life span. To boost their life expectancy that much, Americans had to increase their annual purchases of drugs nearly tenfold. In the ten-year period between 1946 and 1956 retail drug sales tripled from $512 million to $1.5 billion.

The industry should continue to share in the worldwide population boom resulting from a rising birth rate and an increased life expectancy. The human urge to fight disease and postpone death is universal. Sales of drug products are expected to grow rapidly both here and abroad. Increasing volumes should more often offset a modest decline from the height of the industry's profit margin achieved in the 1958-59 period when it luxuriated in profits from its major advances in tetracycline, antibiotics, steroids, diuretics, antidiabetic drugs, etc. The Asian influenza epidemic also bolstered drug profits during that period. In 1960, on the other hand, no major triumph of research was reported despite record research expenditures.

From a long-term viewpoint, consistently high expenditures should mean more profitable products. Anyhow, high-level research is the only way of gaining new markets and fighting competitive threats to existing lines. It's pretty safe to evaluate the quality of drug companies, especially those operating in the ethical phase of the business, on the basis of their ability to maintain a continuous flow of new products via high-level research programs.

The drug industry is essentially made up of two groups: ethicals (prescription) and proprietaries, the latter being closely associated with personal-hygiene products. Ethical drugs account for about three-quarters of total drug sales. In evaluating ethical drug companies, emphasis should be placed on the quality of their research as well as on their ability to turn out profitable new products. On the other hand, the strength of proprietary makers is based on their marketing organization and on their ability to build up and maintain brand loyalties. Generally speaking, the industry's greatest growth potential exists in the ethical field where most drug fortunes were made and will continue to be made.

There are plenty of medical frontiers to be explored. For instance, the battles against mankind's top killers, heart disease and cancer, have hardly begun. As the nation's number one killer, heart  disease  has  understandably  become  the  prime  research target for many drug firms. The most interesting development appears to be Vick Chemical's MER/29, which offers an entirely new (biochemical) approach to heart disease. Vick is a diversified operation in ethical and veterinary drugs, proprietary drugs, and chemicals and plastics.

Basically, MER/29 is designed to reduce cholesterol in the body by inhibiting its production. Since a substantial number of medical experts believe there is a link between excess cholesterol and heart troubles, the introduction of MER/29 could be of major significance. If the relationship between cholesterol and heart disease should be definitely established, the potential market for MER/29 would be enormous. Trade sources estimate that total sales of all types of cardiovascular drugs, currently running at $180 million a year; should approach $450 million by 1970.

Cures remain to be found for cancer, multiple sclerosis, muscular dystrophy, and a wide range of degenerative diseases. An effective vaccine has yet to be found for the common cold. Several firms are developing a live virus for immunization against measles. Mental health research is still in its infancy. Drug researchers are in search for vaccines against hepatitis (a liver ailment), staphylococci and sleeping sickness.

Closely allied with the drug industry is the cosmetics-toiletries industry. The two industries have made each other objects of diversification. Supported by an established position in proprietary drugs, Bristol-Meyers, for instance, is aggressively expanding into ethical pharmaceuticals and cosmetics. Its diversification into cosmetics came primarily through its 1959 purchase of Clairol, the nation's largest maker of hair coloring. This cosmetics merchandising subsidiary accounted for about 17 and 23 per cent of the company's sales and earnings respectively in 1960. On the other hand, cosmetics leaders like Chesebrough-Pond's and Shulton have increasing stakes in proprietary drugs.

Like the drug industry, the cosmetics-toiletries industry also possesses  superior defensive  qualities.   Recession  notwithstanding, industry sales have advanced in every year since 1947. Over the last decade, growth has been pronounced, increasing at a compounded rate of 8 per cent annually, more than double that of the economy as a whole, and comparing advantageously with other recognized growth groups such as chemicals (6.8 per cent) and proprietary drugs (6.5 per cent).

Contributing to this strong growth are the broadening markets via a dramatic increase in per-capita consumption, shifts in the composition of the population, greater acceptance of cosmetics as necessities rather than luxuries, penetration of the relatively untapped foreign market, and the unabated increase in consumer disposable income.

One of the brightest prospects for the beauty industry is accelerated growth expected from what researchers call the changing age composition of our population in favor of the teen-through-middle-age groups, the largest consumers of cosmetics and toiletries, as well as from a more realistic correction of the outdated idea of cosmetics as frivolous nonessentials.

Growth will come from still another direction—the male segment of the population which until recent years had remained virtually untapped but which is becoming a fast-growing market as the young generation comes of shaving age and becomes more conscious of good grooming habits.

Analysts favor the leading companies such as Avon Products and Shulton because of their better competitive position in an industry where sales depend heavily on costly television and other mass-media advertising.

Avon's steady growth is the result of its unique selling methods. Their cosmetics are sold house-to-house by over 125,000 "representatives." These representatives are mostly housewives who wish to earn extra pocket money. Avon is the only cosmetics company to achieve institutional status in the securities market because of its exceptional record of sales, earnings and dividend growth, increasing some 350, 455 and 390 per cent respectively over the past decade.

A leader in male-oriented cosmetics, Shulton has since 1951 achieved an outstanding record of uninterrupted sales and profit growth. Achieving the widest net profit margin in the cosmetics field is Beauty Counselors, a small company which has capitalized on the highly successful, low-cost door-to-door merchandising.

Another small but fast-growing company is Charles of the Ritz, Inc., an aggressively managed growth company that has succeeded in establishing for itself a matchless name for quality in an outstanding line of prestige cosmetic products. At its June 1961 level of 33, the stock was estimated at about 23 times this year's earnings estimates—a ratio which appears quite modest compared with a multiple of about 37 times for a group of well-regarded cosmetic issues.

Among the most promising listed cosmetic stocks is Revlon, which has vast growth potential because of its new products, expansion of foreign market and diversification into new areas.

Particularly interesting is its "antiwrinkle" cream called "Eterna 27." It won't surprise us if this item alone should exert a dramatic impact on its sales and earnings in the next few years in view of its broad market appeal. Its indicated retail price: $8 per two-ounce jar; $13 per four-ounce jar, etc. A two-ounce jar of this cream is sufficient for about a month's supply assuming once-a-day application.

Also interesting is Colgate-Palmolive, which has entered the fluoridated toothpaste sales battle with a new dentifrice containing stannous fluoride. Stannous fluoride is the prime ingredient of Crest toothpaste, made by Procter & Gamble. The American Dental Association last year officially "recognized" Crest with stannous fluoride as effective in helping to prevent dental cavities.

Colgate is test-marketing its new dentifrice, called Cue, in Texas. The company claimed its formulation of stannous fluoride, a chemical composed of tin and fluorine, is more stable than existing formulas and thus has a much longer shelf life. Colgate also claimed the new toothpaste has a "highly acceptable taste factor."

Another stock with outstanding growth record is Johnson fc Johnson whose new dressing, called Surgicel, caused quite a stir in the stock market early in January 1961. According to Johnson & Johnson researchers, Surgicel is a loosely knit gauze which stops bleeding in two or three minutes. The wound may be closed and the dressing left inside to be absorbed by the body tissues. At present, the gauze is used primarily in major operations and for hemophiliacs, the estimated 20,000 persons in this country who are subject to uncontrollable bleeding. Because of its high cost, it may be some time before Surgicel or a less expensive version is available for ordinary first aid kits.

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