INVESTORS who stomached the 90% plunge in Elan’s share price in the space of a little more than a month earlier this year may take umbrage at the traditional view that pharmaceutical stocks are a defensive play.

Such stocks are thought of as low risk because they are unaffected by ups and downs in the business cycle. The industry, however, has been affected by several high-profile drugs being withdrawn from sale.

Elan’s price plummeted when the group pulled Tysabri, its potential multiple sclerosis treatment, from the market. Other withdrawals over the past eight months include Vioxx, Merck’s arthritis and pain medication, and Bextra, Pfizer’s painkiller.

This has also slowed down the process where regulatory authorities, such as the US Food and Drug Administration (FDA), give new drugs the green light.

Increased competition from manufacturers of generic (non-branded) drugs has caused many investors to conclude that large pharmaceutical groups are to be avoided. “The erosion of the ‘defensive’ tag didn’t just start last year,” said Marie-Helene Leopold, a Paris-based analyst with SG Securities. “It’s been happening for at least three years. Every major drug product in the US has either got a challenge or the threat of a challenge from generic producers, making it very difficult for the investment community to forecast earnings for individual companies.”

Eugene Kiernan, the head of asset allocation at Irish Life Investment Managers, says the sales of American drug companies are more at risk than those of European peers from generic competition.

“In the US, about 30%-35% of pharma sales are at risk over the next three years, compared with about 9%-10% of European companies,” said Kiernan.

With America the home market for eight out of the 10 top-selling drugs in the $500 billion global pharmaceuticals market, it’s clear why generic drug-makers have set their sights on it.

Leopold is downbeat on the prospects for American players in the sector, noting that Pfizer’s market exclusivity for the cholesterol-lowering Lipitor, the world’s biggest-selling drug, is being challenged in the courts there, while the patent of the second top seller, Merck’s Zocor, which also targets cholesterol, expires next year.

Other fund managers believe the tide is turning, however. An American court sided with Eli Lilly in its high-stakes battle over market exclusivity of Zyprexa, an anti-psychotic treatment and the world’s third- biggest-selling drug.

Eli Lilly’s share price has surged about 15% since the ruling and is trading at about $59.60. Adrian Howd, a London-based analyst with ABN Amro, says that has helped fuel a rally in the wider sector.

“Stocks have benefited recently also from earnings growth in the first quarter and increased clarity on safety issues from the FDA after the Vioxx incident,” said Howd.

Generic competition goes with the territory in this sector, he says, and there are good reasons why investors seeking diversity should consider having pharmaceuticals in their portfolios.

“There is no other industry that is less exposed to short-term oscillations in the economy,” he said. “Pharmas will always be a defensive appeal for the simple reason that people who are ill are going to pay for drugs to help them recover.”

Drug firms typically generate a lot of cash and can attack their cost bases when sales are suffering, he adds.

Sector observers believe the demographics of an ageing western society are stacked in favour of big pharmaceutical companies too. The real winners will be companies that successfully predict what drugs will be needed in 10 to 15 years’ time, as that is the typical timeframe for a drug to go through research and development, according to Howd.

Kiernan advises looking for companies developing drugs for a variety of treatments. This is why the UK’s AstraZeneca, GlaxoSmithKline and France’s Sanofi-Aventis count among Irish Life’s holdings, he says. The effects of a drug being scrapped during the expensive research and development phase would be more devastating for a company working on a small list of drugs, he added.

Howd is a fan of GlaxoSmithKline’s extensive list of drugs in development: “The company should come through with further news on its pipeline in the second half of this year.”

Shares in GlaxoSmithKline are trading at about £13.67 (€20), having increased in value by 14% over the past 12 months.

Leopold says Switzerland’s Roche stands out as one of the few stocks in the sector that she likes, given its focus on attaining or retaining market leadership in important areas such as oncology and infectious diseases. Roche shares have edged 8% higher over the past year and are now changing hands at about CHF150 (€97).

Pfizer’s stock has lost 19% of its value over the past 12 months and is trading at about $28.35 (€22.44). Bristol-Myers Squibb is hovering around the same levels that it was this time last year, at $25.52.

Kiernan says valuations across the sector are far from offputting. “The sector has always traded at a premium to the overall market, and the premium is currently well below historical levels,” said Kiernan.

The extent to which the tentative rebound of the sector will last, however, could be down to how Sanofi-Aventis and Pfizer fare in cases against generic drug makers in coming months.