Drug discovery is high-risk, high-reward. It takes about 10 years and $1 billion to bring a new drug to market. And only one of 10,000 new prospects ever makes it to pharmacy shelves. Those that do fetch monopoly-like margins and can bring in billions in sales.

Take Lipitor – the world’s best-selling cholesterol drug – for example. Each $3 Lipitor pill only costs Pfizer about $0.25 to make. So the company collects 90% profit margins.

One way the drug industry has learned to reap those outsized rewards with less risk is through “me-too” drugs. Me-too drugs are essentially copycats – like generics but with fat margins.

For example, after Pfizer’s (PFE) Viagra wowed the market, Eli Lilly (LLY) and Bayer jumped into the fray. Now the market has three drugs – Viagra, Cialis, and Levitra – to treat the same condition. Viagra and Cialis fetch more than $1 billion per year. Levitra, the laggard, still generated $500 million in 2007 sales.

But the me-too well is running dry. These days, the FDA won’t approve new drugs unless they offer a clear advantage over what’s already on the market. Recently, me-too drugs vying to compete with Merck’s Januvia (a diabetes drug) and Gardasil (a cervical cancer vaccine) faced serious setbacks. Neither drug satisfied the FDA’s higher standards.

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Now a new class of drugmakers is taking a slightly different tack: They pick existing drugs and make them better. So a company might make a drug available as a pill rather than an injection. Or it might change a three-pill daily regimen into a once-a-day routine.

These so-called “specialty pharma” companies start with what works and go from there. With thousands of drugs on the market, specialty pharmas have no shortage of lucrative products to choose from. Here’s an example of how it works

Until recently, many schizophrenics had to struggle with a complex dosing routine that included capsules of Risperdal (a popular treatment option). So Alkermes (ALKS), one of the biggest specialty pharma outfits, collaborated with Johnson & Johnson, Risperdal’s maker, to create Risperdal Consta.

The new version is a bimonthly injection, and it generates more than $1.2 billion in revenue a year. Besides Alkermes, investors can choose from a handful of pure-play specialty pharma outfits

Specialty pharmas boast profit margins almost as big as the brand-name drug business 70% or higher. And by modifying drugs the FDA has already cleared, they take on much less risk.

Recently, the industry has far outperformed the general market These five stocks are up 3.5% over the last three months, while the S&P is down 8%. I’ve been busy digging through the short list in search of the best company. If you are looking for a low-risk way to get in on the lucrative drug business, this is a great place to start.

Good investing,

George Huang, editor, S&A FDA Report

Source: Where to Earn Monopoly Profits, Minus the Risk