It isn’t too late to buy health care stocks
As investors re-evaluate their stock portfolios and look to make sense of the new health care reform legislation, a big question now is whether health care stocks are still worth buying.
As investors re-evaluate their stock portfolios and look to make sense of the new health care reform legislation, a big question now is whether health care stocks are still worth buying.
The answer appears to be yes.
Health care stocks have long been regarded by investors as conservative, defensive positions. Their product portfolios include a range of necessary and desirable products, such as pharmaceuticals, medical devices and diagnostics, orthopedic implants, medical-research tools and consumer products.
Health care companies typically hold up well during difficult market environments due to characteristics including patent protection, an aging demographic trend and high levels of free-cash-flow generation. In fact, between Dec. 31, 2007, and Dec. 31, 2009, health care stocks outperformed the broader S&P 500 — despite concerns over health care reform.
The same factors that have made these stocks attractive over the past couple of years — aging populations, emerging-markets opportunities, health care spending trends and valuations — remain in place.
According to the Center for Medicare and Medicaid Services, Americans 65 and older accounted for 12% of the population in 2004. This population segment is expected to grow to 16% by 2020 and to 20% by 2050.
Older Americans spend far more on health care: On average, those 65 and older spend an average of nearly $15,000 a year, versus $4,500 for those between 18 and 64, according to the center.
The result of these domestic trends is that the center expects health care spending to grow 6.2% through 2018, nearly three times faster than the overall 2.1% growth of the U.S. economy.
Internationally, the story is similar. Many nations are moving to increase access to health care services.
A recent presentation by Johnson & Johnson noted that in China, the number of individuals with access to health insurance — and thus greater access to health care products and services — has doubled to 45% since 2001. That coverage is expected to grow to 85% by 2012 with the country’s goal of universal coverage.
India’s covered population is expected to double to 220 million by 2015.
Similar trends are occurring in other countries, including Mexico and Russia.
Increased access to health care globally means more patients and, consequently, more opportunities for growth of the health care sector. Such growth should be supplemented by an inevitable growth in health care spending on a per-capita basis.
According to calculations derived from data in the CIA World Factbook, health care spending in developed markets currently averages 4.5% of per-capita income.
For emerging markets — defined as those with average annual per-capita income of $20,000 or less — average health care spending is just 1.7% of per-capita income. Clearly, an emerging-markets opportunity exists for globally diversified health care companies as these nations’ populations continue to gain affluence.
Health care companies have traditionally generated strong free cash flow and are likely to continue doing so.
Strong growth drivers are their ability to develop new products, increase sales growth and take advantage of enhanced competitive advantages. Products can be tailored to unmet patient needs in relevant markets around the globe.
With all these long-term-growth drivers in place, the question of valuation remains, particularly after the previously noted two-year outperformance. Yet valuations remain compelling when viewed historically.
As of year-end 2009, health care stocks were trading at about a 20% discount to the S&P 500. This is in stark contrast to historical averages.
In the past five years and 10 years, health care stocks have traded, on average, at a 10% premium to the S&P 500. This disconnect is in spite of expectations for increased health care spending and global opportunities.
One influence that remains is the effect of health care reform in the United States. Reform will likely increase access for patients and boost volume, helping to offset pricing pressures and cost controls.
Achieving volume/price balance will be challenging for health care companies, but they have the ability to invest and manage to achieve this balance.
Just as doctors advise patients that they shouldn’t neglect their health, it would appear that investors would benefit by not neglecting health care stocks in their portfolios.
Eric Schoenstein is a principal for business analysis at Jensen Investment Management, a registered investment adviser.
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