Don't Count Out Healthcare Stocks

By Aaron Levitt | January 06, 2012 AAA

As safety became a priority for investors, sectors like consumer staples and utilities became top holdings in portfolios. After all, despite how the general economy is doing, people still need to power their homes and wash their clothes. Absent from this "safe" list was the healthcare sector. Historically a member of the same crew, the sector has been bogged down due to the pending Obamacare legislation. In addition, as the recession took hold, many consumers were willing to forego non-essential procedures and reduce spending on health. However, with long-term population trends firmly in hand, the need for greater healthcare solutions is almost assured. The sector remains an interesting buy going into the new year and variety of factors could help boost shares of healthcare-related firms. (For related reading, see Investing In The Healthcare Sector.)

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A Positive Outlook
Investors may want to consider overweighting healthcare as the new year kicks off. Consumer spending on healthcare finally seems to be turning a corner as the U.S. has seen two sequential quarters of strong growth in personal health expenditures. As unemployment has continued to improve, insurance enrollment has been increasing, leading to the increased spending. Analysts at Morningstar (Nasdaq:MORN) now estimate that personal healthcare spending will outpace GDP growth throughout the year. Despite the 6% slump in doctor office visits according to reports from Quest Diagnostics (NYSE:DGX), there has been a gradual increase in hospital visits.

Additionally, two major developments to the
Patient Protection and Affordable Care Act (i.e., Obamacare) are currently underway. First, The Obama administration recently said it would shift the decision to states governments about which treatments insurance plans must cover under the healthcare overhaul. This move is a major departure from how many analysts and policy makers anticipated how the administration would act and could be a major game changer for the sector. Perhaps more importantly, The Supreme Court has begun the process to see if President Obama's healthcare plan is within legal and constitutional limits.

Finally, investors in the sector may not need to wait for a Supreme Court decision or an increase in healthcare spending to see gains in 2012. Healthcare firms have taken to share buybacks in spades throughout 2011 and analysts estimate that growth will continue in 2012. Average cash deployment toward buybacks among healthcare firms has increased from around 30% in 2009 to more than 50% in 2011. That number is even higher for medical device and instrument makers. On average they have spent around 80% of free cash flow on buybacks. Medical equipment supplier Becton, Dickinson and Company (NYSE:BDX) hopes this strategy will increase their earnings growth. (To learn more about buybacks, read A Breakdown Of Stock Buybacks.)

Playing Healthcare's Rise
For investors, the healthcare sector offers many positives going forward into 2012 and could be a good overweight position. The Vanguard Health Care ETF (ARCA:VHT) remains one of the cheapest options for broad exposure. The fund tracks 307 different firms including heavyweights Pfizer (NYSE:PFE) and Johnson & Johnson (NYSE:JNJ).

Buybacks have helped bolster the equipment maker's earnings over the last year and with more on the way, investors may want to take a bite. According to Morningstar, Medtronic's (NYSE:MDT) mix of businesses has less exposure to Medicare cuts than rivals such as Boston Scientific (NYSE:BSX). Medtronic currently trades at a P/E ratio of around 12. In addition, device maker Covidien (NYSE:COV) has been plowing big dollars into its buyback program.

Perhaps the biggest winners in all of this could be the health insurance firms. Depending on how the states play the required treatment option, could be a wind fall for the insurers. Blue Cross and Blue Shield provider, WellPoint (NYSE:WLP) is positioned well, both nationally and regionally. This will result favorable pricing for the insurer. For investors who want to make a broad bet on the sub-sector, the iShares Dow Jones US Healthcare (ARCA:IHF) can provide access. (For more information on investing in ETFs, read Advantages And Disadvantages Of ETFs.)

The Bottom Line
The healthcare sector remains bogged down in a mire of regulation and dwindling spending. However, there are some bright lights on the horizon. For investors, these major factors could be the catalysts need to propel the sector upwards in the new year. Adding funds like the First Trust Health Care AlphaDEX (ARCA:FXH) or the previously mentioned stocks could be a good way to play the trend.

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At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.

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