A Strong Prognosis For Healthcare Stocks

By Aaron Levitt | November 19, 2013 AAA

As the politicians continue to debate the Affordable Care Act (ACA), the healthcare sector has emerged as one of the stock markets biggest winners. As of the end of October, the Health Care Select Sector SPDR (NYSE:XLV) –which tracks healthcare-related firms in the S&P 500- has returned more than 33% since the start of the year. The prevailing idea is that under the ACA, more individuals have access to insurance and care.

That means there will be plenty of profits for sector as the law rolls out.

And while the ACA has been the driving force in the short term, the healthcare sector still has plenty of longer term catalysts in the wings. From our aging population to rising middle class wealth in the emerging world, the prognosis for the healthcare sector is quite rosy. For investors, betting on the industry still makes plenty of portfolio sense.

A Mired Of Positive Factors

Despite its recent gains, investors may not want to give up on the healthcare sector just yet. That’s because things could just really getting cooking for the industry.

First, the 800lb gorilla in the room is the ACA. According to estimates by the Congressional Budget Office, the law will greatly reduce the number of uninsured Americans significantly. By 2018, the ACA will add another 32 million Americans to insurance rolls. That includes expanded enrollments in Medicaid programs as Obamacare requires states to expand programs for the poor to everyone. While the bill may see revisions, it stands to reason that more people having access to healthcare solutions is a net-positive for stocks within the sector.

Then there is our quickly aging population to deal with. According to the US Census Bureau, roughly 14% of Americans are currently 65 years or older. However, that percentage expected to rise to 25% in about 10 years. Expanded further, that equates to roughly 10,000 baby boomers a day turning 65 years-old, every day for the next 20 years. Similar demographic trends are underway in both developed Europe and Asia. Japan’s 65 and older population now sits at more than a quarter of its population. As our population ages, more and better healthcare solutions will be required and demanded from that older populace.

In the emerging world, the opposite is true. Faster-growing and younger populations in places like Indonesia and China will require more healthcare solutions to prevent widespread epidemics. At the same time, rising incomes and middle class populations will help drive new drug and therapy demand as more people can now actually afford to visit a doctor.

All in all, these factors point to a rosy demand picture for the healthcare industry over the longer term.

Writing A Rx For Your Portfolio.

Given the long-term demographic shift as well as the floor created by Obamacare, investors may want to overweight healthcare stocks. While several have surged- such as Biogen’s (Nasdaq:BIBB) 300% gain- many are still trading for peanuts given their long term potential.

A prime pick could be the Vanguard Health Care ETF (NYSE:VHT) remains one of the cheapest options for broad exposure. The fund tracks 291 different firms including heavyweights Bristol-Myers Squibb Company (NYSE:BMY) and device maker Medtronic, (NYSE:MDT). Year to date, the VHT is up nearly 30%. Overall, the fund is a great broad and cheap way to add the healthcare sector to a portfolio. Expenses for the ETF are just 0.14% Likewise, the iShares US Healthcare ETF (NYSE:IYH) is a good- albeit not as broad in terms of holdings- choice as well.

However, given the overall rise in healthcare stocks, investors may want to be more selective in their choices.

Some of the best plays lie within the wide moated pharmaceutical and biotech firms. After years of struggling many drug makers have vastly improved their development pipelines with higher-tech drugs. Last year, the 21 largest drug makers had 429 biotech products in development. Leading the way are major pharmas Roche (OTCBB:RHHBY) and GlaxoSmithKline (NYSE:GSK). Biotechs have allowed Glaxo to jump-over its “patent cliff” issues and finally realize increasing revenues and earnings per share are rising again. On the pure-biotech side, Amgen (NASDAQ:AMGN) has been cited by analysts for its strong pipeline coming to market in the next few years. However, all of these firm’s current share prices still don’t into account for their newfound pipeline potential.

The Bottom Line

Despite the healthcare sectors recent torrid run, there’s still plenty to like about stocks in the industry. Aside from tailwinds created by the Affordable Care Act, demographics is playing a huge future role in healthcare stock gains. For investors, adding a dose of the industry still seems prudent. The previous picks make ideal selections to the play the growth in healthcare.

Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.

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