Health-Care Investment–The Hidden Crisis
By Michael Milken

The Wall Street Journal
February 8, 2011

Since 1820, world per-capita income has risen more than eightfold, thanks in part to the spread of democracy, open trading markets, and the rule of law. But a less-noted source of growth – improvements to health that have given us longer, more productive lives – has produced as much as half of the increase in the global economy over the past two centuries, as research by the late British economist Angus Maddison suggests. It would be logical to assume that companies whose products make us healthier would be among the most valued enterprises on the planet, but this assumption is wrong.

Consider companies that make consumer products – things like soft drinks, laundry soap, cosmetics and beer. While their price/earnings ratios will vary, in today's market their average will most likely be in the neighborhood of 18. But the average P/E of the largest American pharmaceutical research companies (Abbott Labs, Bristol-Myers Squibb, Johnson & Johnson, Eli Lilly, Merck and Pfizer) was recently near 10. Investors must have concluded that pretzels and eye liner produce faster profit growth than prescription medicines.

Lower pharma P/E ratios are a recent phenomenon. A generation ago, drug firms regularly topped magazine lists of the most-admired companies in America, a reputation usually reflected in their stock prices. But facing the specter of regulated returns, enterprise values dropped sharply during debates about proposed health-reform legislation in 1993. When the proposals failed in Congress, valuations eventually recovered. In the last decade, pharma P/E ratios dropped again.

Contributing to these lower valuations are patent expirations, regulatory complexity, uncertainty about litigation exposure, and high U.S. taxes on repatriated foreign income. These factors undoubtedly influenced the decision by Proctor and Gamble to leave the pharmaceutical business entirely in 2009 and concentrate on consumer products.

P&G responded rationally to clear market signals that discouraged development of life-saving drugs. But for people whose health, and perhaps survival, will depend on these medicines – that includes you and me – the implications of the disparity in market valuations are ominous.

We can remove some of the barriers to growth in medical research through several public-policy steps: