At risk of sounding like a broken record, I will once again beat the drum on healthcare stocks – what I believe should be a foundational investment in every portfolio, regardless of your financial goals.
I’ve written extensively on this trend for some time, so I won’t belabor the arguments for healthcare stocks. They include:
U.S. Demographics: Boomers are aging and need more care. Consider a 2014 report from retirement giant Fidelity Investments estimating that the average 65-year-old couple will need $220,000 to cover medical expenses in old age. That’s a lot of built-in spending for healthcare.
Emerging-Market Growth: According to the World Bank, China spent just 5.6% of its GDP on healthcare in 2013, the most recent year available. The Russian Federation is a bit better at 6.5%, but India is at just 4% of GDP. Compare that with the roughly 10% to 12% that is typical for developed nations including Germany, Japan, Canada and France, and you see the tremendous potential for growth here as modern (and more expensive) cures find root overseas.
Outperformance: Any way you slice it, healthcare stocks outperform. Take the SPDR S&P Biotech ETF (XBI) which is up 350% since May 2007 vs. about 40% for the S&P 500 in the same period. Or consider the relatively boring Guggenheim S&P 500 Equal Weight Healthcare ETF (RYH) — designed to focus only on large-cap healthcare and prevent a single holding from ever dominating the portfolio — which is up almost 180% in that time. For a plain-vanilla index fund, Vanguard Health Care ETF (VHT) is up 125%. Whatever “flavor” you pick, outperformance is the norm.
Of course, this is a general trend. There clearly will be some losers in there … but also some very big winners.
So if you don’t want to sit on your hands with an ETF and are looking for more explosive returns, consider these five unconventional healthcare plays that may offer outsized performance in the years ahead:
Unconventional Healthcare Stocks to Buy: GW Pharmaceuticals (GWPH)
YTD Performance: +78%, vs. 1% for the S&P 500
Market Cap: $2.6 million
GW Pharmaceuticals (GWPH) is a U.K.-based biopharmaceutical company that focuses on cannabinoid-based treatments.
For those of you not hip to the lingo, that means GW is a marijuana stock.
Now, it’s important to address that fact up front because there is undoubtedly volatility in this name in part because of the marijuana focus. But it’s crucial to remember that GWPH is not your typical marijuana penny stock that’s just (pardon the pun) blowing smoke.
GWPH is actually in late-stage development of a viable marijuana-based treatment, Epidiolex, which targets a rare form of childhood epilepsy.
I’ve written a bunch lately on the trend among biotech stocks to chase down so-called “orphan drugs,” which are niche treatments for specialized diseases. Not only do these kinds of medications often get fast-tracked for approval because of a lack of other treatment options, but they also command huge margins because of how specialized and rare these treatments are.
In fact, it was orphan drug appeal that recently resulted in a massive buyout offer for Synageva Biopharma (GEVA) by megacap Alexion Pharmaceuticals (ALXN) — sending shares of GEVA stock from under $100 to over $200 overnight.
Now, no such buyout is ever guaranteed — especially considering that GW is indeed a development-stage drug company that still needs approval and further testing on its major candidate before it ever reaches commercialization.
But the big buzz behind GWPH has resulted in outsized returns year-to-date, showing investors are awfully optimistic about this unconventional healthcare stock right now.
Unconventional Healthcare Stocks to Buy: ISIS Pharmaceuticals (ISIS)
YTD Performance: +6%
Market Cap: $8 billion
If you don’t like the frothiness of GWPH but still want to get into the biotech game, then consider a slightly more established player in ISIS Pharmaceuticals (ISIS).
Isis focuses on “antisense drugs” that use genetic therapies to fight cancer, cardiovascular diseases and other rare disorders. It also has a few treatments already in commercialization, so there is a substantive revenue stream to speak of. Shares have more than doubled in the past 12 months as a result of both continued success and the potential of an acquisition sometime soon thanks to its proven track record and potential drug pipeline.
Why such optimism? It goes back to that idea of orphan drugs.
According to research firm Evaluate Group (PDF link), orphan drugs are seeing breakneck growth and huge potential right now. In a report on these niche medications last year, the group notes that orphan drugs will make up 19% of all prescription drug shares by 2020, hitting $176 billion in total sales.
And in the short term, the 11% growth rate in orphan drug sales predicted this year will be nearly double the 5% growth rate of overall drug sales that include mainline prescriptions and generic medications.
In other words, if you’re a big pharmaceutical company and want a path to growth and big margins, get yourself a new pipeline of orphan drugs.
This means a company like ISIS is ripe for the picking — particularly given it only has a roughly $8 billion market cap while other players in the space are pushing $20 billion and getting downright indigestible.
And if a buyout doesn’t happen? Well, the continued ramp in revenue and the hope of profitability as more of these treatments come to market could keep ISIS investors in the green anyway.
Unconventional Healthcare Stocks to Buy: Merge Healthcare (MRGE)
YTD Performance: +20%
Market Cap: $430 million
Merge Healthcare (MRGE) is a cheap small-cap stock trading for under $5 a share. But this company is not a battered company on the ropes — it’s one of the most exciting stories in healthcare, with the convergence of medicine and technology in one growth investment.
MRGE develops software to help share medical images. And given the rise of digital medical imaging, the ability for doctors to collaborate in the cloud and the need for secure storage in light of hacking and personal information concerns, a company like Merge is in the right place at the right time.
And judging by the 20% jump since Jan. 1 and the fact that MRGE stock has nearly doubled since last summer, it looks like investors agree.
MRGE stock has recently attained steady profitability, and has put together a string of strong earnings reports that have regularly met or topped expectations. Revenue is growing at a double-digit clip annually, and profits continue to edge higher as well.
Q1 earnings for MRGE stock hit at the end of April, showing improvement in the bottom line driven by both organic growth as well as the recent acquisition of competitor D.R. Systems. Shares did sell off from a recent 52-week high in April, but remain up strongly on the year thanks to improving fundamentals.
Merge might be small, but unlike other frothy tech stocks, it is soundly profitable already even as it continues to ramp up its growth plans. That will add some measure of security to this small-cap healthcare play even if it is only a $440 million company.
Topeka Capital Markets recently downgraded Merge to “hold” as shares have rolled back from recent highs, but they also raised their target to $6.25 on the stock — more than 45% upside from here.
That’s quite a vote of confidence.
Unconventional Healthcare Stocks to Buy: Physicians Realty Trust (DOC)
YTD Performance: -3%
Market Cap: $1.1 billion
Physicians Realty Trust (DOC) is a healthcare stock, but also a great income play since it’s structured as a REIT that pays a massive 5.6% dividend.
DOC owns healthcare properties including hospitals and medical-office campuses. But Physicians Realty Trust’s strategy is primarily owning several properties that are close to one another — enabling DOC to tap into the baseline healthcare demand of an area, as well as the post-visit care that so often comes with a hospital stay.
Although performance has lagged a bit in 2015, the company has done quite well in the past 12 months with roughly double the returns of the S&P 500 since last summer. Furthermore, you can’t overlook the total return via that impressive dividend yield.
Admittedly, there isn’t the growth sexy appeal like some of the other biotech stocks on the list. Physicians Realty is a REIT, after all, and has to deliver 90% of taxable income back to shareholders. However, given the tailwind for the sector at large, there is still growth to be had. Consider that, in fiscal 2013, Physicians Realty Trust recorded only $17 million in revenue, and this year it is expected to finish with about $116 million — more than double last year’s revenues.
As a small-cap REIT without much wiggle room in payouts, there are risks, to be sure. However, I’m confident in the long-term trend of healthcare-related REITs in this sector, and the big ramp we’ve seen in Physicians Realty over the past few years should give investors confidence in this aggressive income play.
That will result in not just share appreciation, but also dividend growth that could make DOC stock an amazing long-term income play.
Unconventional Healthcare Stocks to Buy: Sharps Compliance (SMED)
YTD Performance: +40%
Market Cap: $94 million
Of the best small-cap stocks this year, medical waste disposal services firm Sharps Compliance (SMED) is capitalizing big-time on the rise of injectable drugs like insulin to treat diabetes.
SMED is focused on the “sharps” business, disposing of needles and other medical waste in a same manner. Because while doctors’ offices and hospitals may have an easier time of getting rid of this stuff, home healthcare providers, retail pharmacies and even veterinary offices often require injectable medications — as well as a disposal plan — and Sharps is here to help.
Its flagship product is the Sharps Recovery System, which you may have seen in all manner of facilities, from highway rest stops to public restrooms. The basic idea is a sealed, puncture-resistant container that can simply be shut and mailed via the Postal Service to an appropriate disposal facility.
Sharps services most clients via old-fashioned, route-based pickup, but this unique idea of medical waste disposal anywhere is a great concept — particularly in the age of diabetes when injectable medications like insulin are increasingly common in public life.
Now, Sharps has had its trouble with profitability and just posted a deeper-than-expected loss in March. It’s also very small at a mere $94 million in market capitalization and thus ripe for volatility.
However, just look at the $8 target recently put on SMED stock by Stifel Nicolaus — about 35% upside — and you’ll see that the run might just be getting started thanks to the tremendous long-term potential here.
Sharps is a risky play and is sure to be volatile, but could be a great healthcare play for aggressive investors.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not hold a position in any of the aforementioned securities.