Betting on the aging of America

The aging of America is going to hit equity markets like a tsunami moving at a glacial pace.

The aging of America is going to hit equity markets like a tsunami moving at a glacial pace. The proportion of the U.S. population over 65 is projected to increase to 19.6% in 2030, from 12.4% in 2000, according to the Census Bureau. The number of senior citizens will more than double to 71 million in 2030, from 35 million in 2000, and the number of people over 80 is expected to increase to 19.5 million in 2030, from 9.3 million in 2000.

In choosing investments, health care companies will be the primary beneficiary of our aging society, but we recommend being aware of pending legislative changes before making investments in that sector.

Assuming no radical changes in health care, the most obvious beneficiaries of an aging society are drug companies.

Pfizer Inc. (PFE), Merck & Co. (SGP) and Eli Lilly & Co. (LLY) are pharmaceutical giants that almost certainly will benefit as a growing number of seniors require more prescriptions and as Medicare coverage is expanded. All three companies offer solid balance sheets and impressive arsenals of new drugs awaiting approval from the Food and Drug Administration.

Pfizer alone spends more than $7 billion a year on research and development, and now has 25 drug compounds in Stage 3 clinical trials and 100 drugs in its pipeline, covering everything from breast, prostate and lung cancers to Alzheimer’s disease and dementia.

Merck, which is a smaller company than Pfizer, has nine drugs in Stage 3 clinical trials and 47 new drug compounds in its pipeline.

Lilly has seven drugs in Stage 3 and 53 total drugs in its pipeline.

Looming patent expirations have depressed the stock prices of these companies and will be a lid on future stock appreciation, but large dividend yields of 4% for Pfizer, 4.8% for Merck and 6% for Lilly make these stocks attractive candidates for income-oriented investors.

Possibly an even bigger beneficiary of an aging society will be Teva Pharmaceutical Industries Ltd. (TEVA), which is the world’s largest provider of generic drugs. More than 60% of all drugs dispensed in 2008 were generics, and that figure is expected to rise to 75% by 2012 as several blockbuster drugs, including Pfizer’s cholesterol drug Lipitor, lose patent protection, according to CVS Caremark Corp. (CVS).

Perhaps the easiest way to invest in the aging of America is through your local drugstore — CVS or Walgreens (WAG). CVS has been gearing up to handle the coming demographic wave of retirees by buying Longs Drug Stores, Eckerd, Revco, and Albertsons Sav-On and Osco stores, making CVS the nation’s largest pharmacy dispenser, with 6,900 stores in 41 states.

Furthermore, CVS also has purchased Caremark LLC, one of the nation’s largest pharmacy benefit managers. These acquisitions allow CVS to achieve large economies of scale, improve margins and offer better service to large national accounts.

Walgreens also is attractive, with a strong balance sheet and its internally generated growth model. Walgreens has been expanding its own stores through remodeling and expansion into new markets, and in fiscal year 2008 produced its 34th straight year of record revenue and earnings gains.

In addition, Walgreens has been a steady buyer of its own stock over time and just recently increased its dividend by 22%.

Medical-product companies will also be big winners.

Among them will be Johnson & Johnson (JNJ), which besides being a well-known consumer product, health care and pharmaceutical company, is also the world’s largest medical-devices and diagnostics company. J&J has the No. 1 or 2 position in the majority of markets in which it competes, and serves such diverse health care needs as ophthalmology, cardiology and surgical care.

Other strong medical-product companies include Abbott Laboratories (ABT) and Medtronic Inc. (MDT), both of which have actually increased earnings during the financial crisis.

Finally, several industries outside the health care arena will also directly benefit from the aging of America.

Financial services firms will benefit from retirees who need help with retirement planning and asset management.

Also, publicly traded real estate investment trusts that specialize in senior housing and nursing homes will experience growing numbers of residents.

James Schnieders, William Schnieders and John Schnieders are principals at Schnieders Capital Management LLC, a registered investment adviser.

For archived columns, go to InvestmentNews.com/investmentstrategies.