Sunday, February 28

Week 243 - S&P 500 HealthCare Companies

Situation: Obamacare has been a boost for the healthcare industry, bringing 10 million new health insurance clients into the system. And, the Federal Reserve’s main monetary policy since the Lehman Panic, called “quantitative easing,” invested $4.2T (that’s Trillion) in government bonds to bring interest rates down to historic lows. That got people to stop investing in bonds and instead expand their businesses, build manufacturing plants, buy cars, refinance homes, advertise their services, or simply buy stocks. It worked, and investment dollars favored the HealthCare industry. The only “fly in the ointment” is that stocks have become overpriced because bonds are no longer able to compete on a total-return basis. The Federal Reserve is now trying to reverse its “easy money policy” because the economy no longer needs life support. However, this will sink the stock market for a while, including healthcare stocks. But those of you who are building a retirement portfolio can hardly avoid the obvious benefits of owning healthcare stocks, which are a growing client base and an aging population. And that’s just in the United States. Looking internationally, there are almost 20 million people emerging from poverty each year and now able to invest in their health! 

Mission: You’ll need to know which stocks you might want to drop and which you might eventually profit from owning (and should probably continue to dollar-average into). So we need to come up with a list of the highest quality HealthCare stocks. We’ll use our standard spreadsheet to highlight both the past rewards of ownership and the likely risks of continued ownership. We’ll start with the list of healthcare stocks in the S&P 500 Index, deleting any with insufficient revenues to appear on the 2015 Barron’s 500 List. We’ll also delete any stocks that haven’t been trading long enough to appear on the 16-yr BMW Method list. Finally, we’ll delete any companies that don’t have S&P bond ratings of at least BBB+ and S&P stock ratings of at least B+/M. 

Execution: The above exercise leaves us with 20 companies to consider, only 5 of which are S&P Dividend Achievers (denoting 10+ years of annual dividend increases). Those 4 companies are: Johnson & Johnson (JNJ), Abbott Laboratories (ABT), Becton Dickinson (BDX), Medtronic (MDT) and Stryker (SYK). The other 15 are speculative investments to varying degrees (see Columns D, I, J, K, and O in the Table). The benchmark mutual fund, Vanguard HealthCare Fund (VGHCX), shows stronger risk-adjusted performance than the aggregate of 20 stocks (compare Line 22 to Line 25 in the Table). Its outperformance has been remarkable for decades.

Bottom Line: HealthCare stocks have become a “crowded trade.” If you’ve held several of the 20 stocks on our list over the past decade, you’re likely happy with your choices. The HealthCare industry will likely continue to do well given the demographic trends in the US and internationally with bigger percentages of people becoming insured, entering their sunset years and emerging from poverty. Just keep in mind that the value of these stocks is technology-driven, and a price-appreciation graph for technology-driven stocks will continue to look like a roller-coaster (see Column O in the Table). Only 3 of these stocks have a steady and strong trend of price-appreciation: Johnson & Johnson (JNJ), Abbott Laboratories (ABT), and Becton Dickinson (BDX). If you want to venture beyond these safe havens, the safest and most rewarding move looks to be the mutual fund that represents this industry so well: Vanguard HealthCare Fund (VGHCX) at Line 24 in the Table.

Risk Rating: 6

Full Disclosure: I dollar-average into ABT and also own stock in JNJ, BDX, and MCK.

NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX, our key benchmark at Line 27 in the Table. Total Returns in Column C of the Table date to 9/1/2000 because that marks the peak of the S&P 500 Index before the “” recession. There have been two peaks since, in 2007 and 2015, so we’re entering the third market cycle since 2000.

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