NEW YORK (MONEY Magazine) - The collapse of tech stocks since March 2000 has been so devastating that lesser disasters aren't getting the attention they deserve.

Pharmaceutical giants were premier growth stocks throughout most of the 1990s. And despite current problems, the group stands to profit mightily from long-term increases in the demand for health care as the population ages.

Nonetheless, over the past 18 months or so, the share prices of big drug companies have dropped as much as 56 percent, and most analysts have turned bearish on the group.

At today's prices, the sector does offer some bargains. But the industry still faces difficult business conditions over the next two or three years, and no single drug stock is a screaming buy right now. Choosing the one that will be most worthwhile over the long term depends on the type of investor you are.

To some extent, the drug stock crash has resulted from some of the same excesses that set up tech stocks for a fall. Drug shares were clearly overpriced before the sell-off began. They greatly outpaced the S&P 500 index during the late 1990s, and at the peak 18 months ago, shares of the biggest U.S. drugmakers were trading at price/earnings ratios 50 to 100 percent above the broad market's multiple.

Price decline from 52-week high       Bristol-Myers Squibb (BMY) down 56% Abbott Laboratories (ABT) down 31% Eli Lilly (LLY) down 31% Merck (MRK) down 31% Pharmacia (PHA) down 24% Pfizer (PFE) down 22% Wyeth (WYE) down 20% Johnson & Johnson (JNJ) down 12% (Note: Data as of June 11)

Once the recession began, though, much of that premium disappeared. Current earnings trends are disappointing, and it now appears that, until 2004, average profits for the group will rise more slowly than those of the typical blue chip.

The key questions for bargain hunters are the strength and timing of the inevitable recovery. The '90s drug stock boom was based on three factors -- superior earnings growth, exciting new technologies and favorable long-term demographic trends such as the aging of the baby boomers. The demographic trends haven't changed, of course, but the promise held out by new technology such as genetic engineering has been slow to materialize.

Megamergers enabled leading pharmaceutical companies to pump up profits. Margins can improve in the first few years after a merger, as unnecessary costs are trimmed and the combined product lines are pushed through a downsized sales force. But the bigger companies eventually require even larger numbers of successful new products to maintain above-average earnings growth.

Those innovative products aren't coming easily. Biotech has been able to create only a few billion-dollar drugs. And traditional R&D hasn't been developing blockbuster drugs fast enough to replace those that are losing patent protection. New drug flow is now running consistently below historical levels, and the rate of patent expirations over the next five years will be nearly double that of the late '90s.

As a percentage of the total U.S. drug market, products coming off patent will reach almost 10 percent a year. Moreover, as blockbuster drugs lose patent protection, companies not only face competition from high-priced rivals but also from cheap generics that force price cuts for everyone. The combined effect can be severe. Earnings for Eli Lilly, for instance, fell 22 percent in the first quarter, largely as a result of generic competition for the antidepressant Prozac, which lost patent protection in the U.S. last year.

Despite these concerns, there's a compelling argument for long-term growth investors to include big pharma in their portfolios. At some point, advances in genetic engineering and biotechnology will likely lead to a torrent of new drugs. In addition, the aging population will increasingly suffer from the types of chronic ailments that can usually be treated most efficiently with drugs, even if surgery or other alternatives are available. Together, these trends should be sufficient to create industrywide profit growth of more than 15 percent a year over the long term.

Equally important, the drug giants offer a degree of diversification that's hard to obtain otherwise. Most blue-chip growth stocks are connected in one way or another to computers, telecom or the Internet. Big pharma, by contrast, is the one major growth sector that doesn't march in step with tech.

Although there's no single best buy among the drug stocks right now, there are several ways to cash in on the diversification and long-term growth potential the sector offers. Selecting the one that's best for you depends on your objectives and appetite for risk.

Fund investors who want the simplest choice (and are comfortable with a $25,000 minimum investment) should consider Vanguard Health Care (800-851-4999), which has returned 20 percent annually over the past 10 years and 16 percent over the past three.

Growth investors who are willing to pay a premium for the best of breed will find Pfizer (PFE: Research, Estimates) appealing. The largest U.S. drugmaker boasts eight different billion-dollar products, including the antidepressant Zoloft, cholesterol reducer Lipitor, and Viagra. In addition, Pfizer's product pipeline looks strong, thanks to spending more than $5 billion a year on research and development.

Long-term earnings growth is projected to be better than 17 percent a year. At around $35 a share, Pfizer trades at 22 times estimated earnings for the current year. That's cheap compared with the stock's 30-plus P/E over much of the past five years. Pfizer's weak spot: The company has already announced that results for the next quarter or two may come in below expectations, with growth dropping into the single digits.

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Patient value investors should take a look at Merck (MRK: Research, Estimates). The company's current earnings are disappointing because of key drugs that have come off patent. In addition, the new-product pipeline looks skimpy. As a result, Merck is projected to turn in subpar annual profit growth in the 10 to 11 percent range over the next five years.

Still, the stock is cheap enough to be quite attractive as a value play. At around $52.50 a share, Merck is trading at less than 17 times this year's earnings. The company's assets and R&D capabilities remain substantial. And when Merck cleans up its act, it will be accorded a higher valuation -- although that probably is a couple of years away.

Risk-averse investors who put a premium on low volatility may feel more comfortable with Johnson & Johnson (JNJ: Research, Estimates). The company diversifies its prescription-drug businesses with over-the-counter products and health and beauty aids such as Tylenol, Band-Aid and Neutrogena soap products. The stock isn't undervalued at a recent price of $58 a share and 26 times this year's earnings, but that P/E appears justified by J&J's consistency. Thanks to the company's diversity -- with 197 different businesses selling in 175 different countries -- earnings have grown at a steady 13 to 14 percent annual rate since the mid-'90s, and J&J has raised its annual dividend 38 years in a row.  

Michael Sivy can be reached at sivy_on_stocks@moneymail.com.