Checking Up On Health Care
Nobody knows for sure whether the health-care sector is genuinely sick or just has the sniffles. The stocks show enough symptoms to warrant caution regarding the sector as a whole, but the Forecasts sees a lot of promise in select health-care stocks.
Health-care stocks make up about 14% of the capitalization-weighted S&P 1500 Index of large, medium-size, and small stocks. In contrast, health-care stocks represent 22% of our fully invested Long-Term Buy List, 23% of the Focus List, and 27% of the Buy List. Our sister publication Upside, which focuses on small-cap stocks, has 26% of its Buy List in the sector.
While the Forecasts and Upside do not explicitly choose to overweight or underweight any specific sector, neither will they set their exposures based on the market’s weightings. Our sector weightings depend on our ability to find high-potential stocks in a sector — and right now, several health-care stocks look pretty good.
The average health-care stock in the S&P 1500 Index earns a 73 Overall Quadrix® score, with 70 in Momentum and 62 in Value. All three of those scores are near their highest point in the index’s 15-year history. Quadrix scores are percentile ranks, with 100 the best.
Sector-specific Quadrix scores help us skim the cream from the top in a large sector packed with fundamentally strong companies. We use the Sector score, derived from 12 statistics that work particularly well for health-care companies, and the Reranked Overall score, which sticks with the category scores used to calculate the traditional Overall score but places higher weight on those that work well in the sector.
In rolling 12-month periods since the S&P 1500 Index was introduced in 1994, the top one-fifth of health-care stocks in the index as measured by the Sector score outperformed the average health-care stock by an average of 7.1%. The top Reranked Overall scorers averaged outperformance of 2.8%.
Health care offers a mix of growth and value difficult to find in today’s market. The average health-care stock in the S&P 1500 Index delivered double-digit growth in sales and per-share profits over the last year and trades at a 34% discount to its five-year average price/earnings ratio.
While the sector looks good fundamentally, recent share-price action suggests investors are worried. The S&P 1500 Health Care Sector Index is roughly flat so far this year, lagging the broader S&P 1500 Index, which is up slightly. Weakness in drug and biotechnology stocks has weighed on the sector, offsetting strong gains in health-care technology and life sciences. While some of the sector’s weakness can be attributed to investor rotation into more cyclical sectors, other factors are also in play.
Investors have reacted negatively to President Obama’s health-care proposals, which include creating a government health-insurance plan to compete with private insurers. While polls suggest consumers favor such a plan, the costs would be huge, and the effects on health-care companies uncertain. Obama has also proposed $313 billion in health-care spending cuts over the next decade, another position that resonates with voters but gives some investors the shakes.
In recent weeks, the government has made cost-cutting deals with insurers, doctors, hospitals, medical-device makers, and pharmaceutical companies. For more on how Obama’s plans could affect investors, check out our health-care Q&A .
Recent comments from both political and business insiders suggest the Obama administration wants to make it easier for companies to market copycat versions of branded drugs, even the biotechnology drugs that have heretofore avoided generic competition in the U.S. Not surprisingly, drug and biotech stocks have come under pressure this year.
Many consumers have put off medical procedures during the current recession, and tight municipal budgets have further upped the pressure on hospitals. Industry watchers say hospitals’ spending on supplies and equipment could fall as much as 20% this year. As the economy recovers, so should the ability and willingness of both consumers and hospitals to spend — but that recovery will not take place overnight.
The Forecasts is comfortable with a healthy weighting in health-care stocks, but investors should focus on our top picks, such as those listed below. AmerisourceBergen ($18; ABC) is being initiated as a Long-Term Buy this week. Hospira ($39; HSP) is being added to the Focus List, while St. Jude Medical ($41; STJ) is being removed from the Focus List but remains a Buy and a Long-Term Buy. You can read more about the stocks in Portfolio Review. Focus List Buy Biogen Idec ($45; BIIB) is featured in Analysts' Choice.