Health-Care Q&A


Q What is health-care reform supposed to accomplish?
A According to President Obama, any reform plan must meet two goals:

Controlling costs.
Providing relief to the uninsured and underinsured.

Of course, the sticking point is how to achieve those goals, which is why a consensus reform plan has yet to emerge. Obama has provided few details on what he wants, apparently leaving it to Congress to come up with a broad framework for reform. However, virtually every plan intimated by Obama and floated by Democratic leadership includes the establishment of a publicly funded insurance option that would compete with private health insurers.

Advocates of a public option believe such a structure would keep private insurers honest while providing new choices for consumers. Opponents of a public insurance plan see it as creating an uneven playing field, with private firms competing against a rival with virtually no cost of capital (because it would be subsidized by tax dollars), vast economies of scale, and no profit incentive.

With so much still in doubt, it is difficult to project winners and losers for investment purposes. Managed-care companies and hospital operators appear to have the most to lose, but it is still too early to tell.

Q How much will this reform cost?
A While headlines on health-care reform blaze across the top of many newspapers, strategies for paying the bills have, for the most part, remained below the fold. Obama believes that health-care reform should not add to the deficit. Many argue that you cannot provide universal access with numerous options and still control health-care costs and remain budget-neutral without large tax increases. A preliminary report from the Congressional Budget Office estimated that the first major Democratic health bill could cost about $1 trillion over the next decade, while covering only about 35% of the estimated 45 million people currently without health coverage.

Many of those pushing massive health-care reform seem to believe investments in health-information technology and other infrastructure can reduce federal costs by hundreds of billions of dollars between 2010 and 2019. Not surprisingly, others claim such savings are illusory.

Given the complexities and contentious nature of health-care reform, it is tough to determine what the final package will look like. However, while Obama has made reform a priority, companies in the health-care sector may benefit if the plan proves too expensive to implement without public backlash. A scaled-down (read: cheaper) version is likely to encroach on fewer business models.

Q What is the bullish case for health-care stocks?
A These stocks offer an appealing combination of value and operating momentum. As this week’s cover story indicates, many health-care stocks earn high Quadrix® scores.

Demographics also support the long-term bullish case. The need for health-care services increases with age. According to U.S. Census Bureau estimates, the world’s 65-and-older population will triple by 2050, representing one in every six people.

Finally, worries of a worst-case scenario for health-care companies have helped drive down the prices of many health-care stocks. Those stocks could rally sharply if the reform plan proves less onerous than investors fear, especially if legislation commits more tax dollars to health spending without imposing big price cuts.

Q What is the bearish case for health-care stocks?
A Bears fear health-care reform will be so pervasive, with the government taking on a huge role both as a buyer and underwriter of health care, that the private sector will be crowded out. Lower profits and greater regulation could reduce the incentives for taking risks and slow the flow of new products. When profits fall and product pipelines dry up, stock prices tend to decline.

Q Which scenario does the Forecasts support?
A We consider it dangerous to lump all health-care stocks together. Health insurers seem especially vulnerable to government-controlled health care, while makers of generic drugs and health-care technology could benefit from a broadened government role. However, even those fairly simple conclusions are just educated guesses at this point.

We have already begun to see reform proposals contort during these early stages of the legislative process. Horse-trading will continue in coming months, and the worst-case scenario already baked into many health-care stocks may not come to fruition. Thus, select health-care stocks with strong Quadrix scores, modest valuations, and operating momentum should outperform over the next 12 months.

Q Given the uncertainty, is health-care still “defensive?”
A Yes, the Forecasts still expects health-care stocks to be relative-strength leaders during down markets. Health-care stocks’ earnings and revenue growth should hold up better than most during economic softness, and today’s cheap valuations provide additional downside protection.

To be sure, ongoing debate about reform does erode the defensive qualities of some corners of the market, such as health insurance and hospital management.

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