The pharmaceutical sector is a consistent value creator, according toanalysts Genghis Lloyd-Harris and Vikram Sahu at Credit Suisse First Boston. A firm that earns a return above the cost of its capital is said to be a value creator. On the calculations of the analysts, the drug sector's cost of capital is around 11%-12%. On this basis, most pharmaceutical firms are consistent value creators. Messrs Lloyd-Harris and Sahu's global analysis of 23 firms from 1993 to 1995 found only three firms that regularly earned less than the cost of capital. These were Schering AG of Germany, Sanofi of France and Merck KGaA of Germany.
Value created by the sector, known as economic value added (EVA), is calculated by multiplying investment capital by the spread between return on invested capital (ROIC) and weighted average cost of capital (WACC), say the analysts.
They note that the 2.5% decline in the drug sector's ROIC from 1993 to 1994 is a result not of lower margins, but of an expanded capital base. Invested capital increased by 27% from 1993 to 1994, and by another 18% in 1995. In fact, say the analysts, the sector improved its ROIC between 1994 and 1995 despite the 18% increase in its invested capital.
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