Week 154 - Healthcare Companies

Situation: Stocks issued by healthcare companies are safe and rewarding investments. Why? Because healthcare goods and services are essential in good times and bad, and prices for those goods and services increase faster than the Consumer Price Index. Also, the healthcare sub-industry is a branch in the Consumer Staples industry, which is the least risky of the 10 S&P industries.

But the Affordable Care Act (ACA) has upended all that. Stocks issued by healthcare companies have become dice in a floating crap game. No one knows how many of the 40 million previously uninsured citizens will buy subsidized health insurance, nor do we know how much they will utilize the medical care system. But if 30-35 million do participate, there’s going to be a doubling of revenues in healthcare companies across the board--given that most of that demographic is chronically ill. That is why stock in healthcare companies is now being priced at imprudently high multiples of the past year’s earnings, with P/E ratios running in the 30s. Those stocks are priced as though the bonanza will happen next year. Common sense and math tell us that can’t happen. This means a lot of “hot money” has entered the market, and that hot money can be counted on to leave the market just as fast. You, the cautious long-term investor, will be left holding the bag of shares that may be worth less than you’d paid. However, long-term investment strategies, such as those we employ, caution you to not be too fast to sell those shares. Better earnings will lift their value over the next decade, and probably a lot.

For this week’s Table, we’ve pulled all the healthcare stocks out of two databases: the Dividend Achievers list, and our own Watch List (see Week 139). That exercise yielded 13 companies but we cut 3 because they had an S&P Bond Rating lower than A-. As always, red highlights denote underperformance vs. the Vanguard Balanced Index Fund (VBINX), which is our benchmark.

Bottom Line: This is not a good time to start a new position in healthcare stocks. But if you do, invest small amounts regularly through a Dividend Reinvestment Plan (DRIP). That way, you won’t be hung out to dry when the “smart money” investors sell. If you continue making regular purchases, you may find yourself buying stock in a fine company at illogically depressed prices. You’ll be accumulating much shares faster, and your dividends will grow quicker. Company earnings will still be on an upward path, and annual dividend increases will likely grow at a faster rate than before the ACA. Healthcare stocks will continue to be a good investment, just scarier. 

Risk Rating: 7

Full disclosure: I dollar average into DRIPs for JNJ and ABT, and also own shares of BDX.

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com