Healthcare Stocks Are Tempting, But Don’t Buy Just Yet

by Tim Melvin | April 10, 2014 9:06 am

The healthcare sector has sold off considerably in the past few weeks. Much of it has been spurred by biotechs finally taking a break after a somewhat torrid run the past year.

The selling spread beyond biotech stocks, though, as the Healthcare SPDR ETF (XLV[1]) is off almost 2% in the past week. This has sparked a great deal of discussion about a potential buying opportunity in healthcare stocks. Healthcare has been a leading sector for several years, and investors have been looking for a chance to buy the dip in healthcare stocks.

It makes sense. Healthcare is one of the few GDP components that grew without missing a beat during the recent recession. According to the Congressional Budget Office, healthcare will rise from the current level of 17% of GDP to 22% by 2038.We are getting older as a nation, and baby boomers are now getting to the age when healthcare usage ramps up as a result of aging.

Private equity firms have said that healthcare is one of their major focus areas as they see a continued streak of strong earnings and cash flow generation by healthcare stocks for an extended period of time. There can be no doubt that the healthcare business should do pretty well going forward, but the real questions for investors is whether healthcare stocks are cheap enough to buy right now.

Warren Buffett once said that you pay a high price for a cheery consensus on Wall Street, and that is the case right now for healthcare stocks. I might not be able to argue the economics of the healthcare industry, but I can use numbers to argue against buying healthcare stocks on the recent pullback. There aren’t many cheap healthcare stocks available, because the bright future of the industry is already reflected in most individual company valuations.

I looked at the question from several angles. When I use my standard value measurement of price-to-book-value, I find very little in the sector to even consider. When I look at the 591 healthcare stocks in my stock screening program, only 23 sell below book value. Only four of these have market caps of more than $100 million, and none of these four trade in the United States. None of them pass my basic financial test, and none offer any margin of safety whatsoever. There are no deep-value healthcare stocks right now.

When I use the more relaxed Graham number — which uses earnings as well as assets to measure value — the results are a little better. There are five stocks that pass both the cheap and safe tests.

One of those is larger than a nano-cap and is easily traded here in the states. National Healthcare Corporation (NHC[2]) operates long-term health care centers with associated assisted living and independent living centers. It operated 73 long-term health care centers with 9,410 beds, as well as 37 homecare programs, five independent living centers, and 17 assisted living communities. The stock currently trades at 78% of its Graham number valuation and could be considered a potential bargain issue.

Even if I use the more growth-oriented price-to-earnings-growth measure, I find very few names in the healthcare sector right now that are cheap compared to their growth rates. There are only 28 names in the global database with a PEG less than 1. Of those stocks, only Aetna (AET[3]), CR Bard (BCR[4]), Healthnet (HNT[5]) HealthSouth (HLS[6]) and United Healthgroup (UNH[7]) are easily traded in U.S. markets.

Healthcare probably will continue to be a growing business, both in the United States and around the world. However, this bright outlook is widely known and appears to be more than priced into the current stock prices. It will take a lot more than the recent pullback to create a buying opportunity in health related stocks for long-term investors.

As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2014/04/healthcare-stocks-xlv-nhc/

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