Six ways to invest in healthcare (afr.com)

Investing in the health sector has always been an important focus for
professional investors, but Covid-19 has drawn a whole new cohort of private
investors to the opportunities that exist across the health spectrum.

The diversity in health is staggering, ranging from the most speculative smallcap
growth plays researching new drugs to some of the most defensive, large
scale value companies offering stable dividend streams through the sale of
pharmaceuticals or hospital services.

Somewhat surprisingly, healthcare stocks have underperformed global markets
over the year to October 2021 after enjoying above market returns for many
years. The sector lagged as investors positioned for an economic reopening by
rotating into more economically sensitive industries and selling down small
and mid-cap biotech companies after strong gains in 2020.

Generally, developed markets health systems are being challenged by ageing
populations and increasing demands on health services, increasing rates of
chronic disease, costs of medical research and innovations, and making the
best use of emerging health technologies and health data.

Even before the Covid-19 fiscal response in Australia, health spending was
about 10 per cent of gross domestic product, meaning that $1 in every $10
spent went to health spending.

The advantage of investing in health care stocks is that the sector is expanding
at a faster rate than the broader economy. And despite governments efforts to
rein in the growth of spending and drive further efficiencies in the healthcare
system, overall health spending is likely to continue to outstrip GDP as private
individuals spend an increasing amount of their disposable income on
longevity and wellness.

Historically, many of the health sector profit pools have grown at annualised
rates of 5 per cent or more. But COVID-19, and a rebalancing of the way
governments and individuals spend their funds, are more likely to place added
pressure on the growth rate in profit pools. New and innovative business
models that focus on delivering better care or products more efficiently will be
required by companies to generate higher returns.

There are 6 broad industry classifications in the health sector: each with their
own volatility and performance characteristics.

Medical equipment makers range from companies that make bandages to
those firms that make complex and expensive high-tech machinery used in
medical procedures. Providers and Services is a very broad category ranging
from distributors and wholesales of health care products to those companies
that manage hospitals and other care facilities. Healthcare technology
companies are those that provide services software and IT services primarily to
doctors, hospitals or businesses operating in the primary care network.
The pharmaceutical category includes companies engaged in the research,
development or production of prescription and over-the-counter drugs, often
creating a stable stream of revenue from continued sales. Biotech firms on the
other hand are far more speculative in nature, with their focus on genetic
analysis and engineering and includes companies specialising in protein-based
therapeutics to treat human diseases. Investors in these companies can wait
years for a financial payoff as testing and regulatory approval processes take
their course. Life sciences tools and services companies support
pharmaceutical companies and biotech firms by providing analytical tools,
instruments, consumables & supplies, clinical trial services and contract
research services.

Large pharmaceutical and biotech companies tend to rank well on quality
metrics with a strong return on equity and a relatively low volatility in earnings
growth. While some of the small-cap companies tend to demonstrate more
equity momentum characteristics – with strong positive earnings revisions and
relatively lower value and quality characteristics.

Value conscious investors tend to focus on the large mega-cap stocks for their
strong cash flow characteristics. Companies in this cohort include Johnson and
Johnson, Pfizer, Gilead, and GlaxoSmithKline. Interestingly, the companies that
been involved in developing vaccines for Covid, including Moderna, all exhibit
high expected return on equity and relatively low earnings volatility.

Healthcare stocks offer an extraordinary array of diversity and risk profiles for
investors. Growth and value, aggressive and low-risk opportunities all reside in
this important sector. Despite heightened sensitivity to government regulation
and political currents, health expenditure is still likely to expand at strong rates
over coming years. But given the shifting landscape and increased competition
in profit pools, investors are going to have to do their homework if they want
to capture the above market returns that are likely to be on offer.