Through the first 8 years of the noughties, global healthcare stocks were notable underperformers. There was an aversion to “paying up for growth”, considerable concerns about the patent expiry cliff and government spending cuts. As a consequence, valuations became progressively more attractive. The long term outlook for the sector was and remains attractive given ageing populations with expectations of remaining active well into old age and the money to achieve this.
This underperformance ended after the Global Financial Crisis and Healthcare stocks have been a great place to invest in the past five years with the MSCI World Healthcare Index delivering an annualised total return in excess of 17% in USD. Over the same period, MSCI World Index returned 12% per annum. Heathcare stocks have performed almost as well as the Tech heavy NASDAQ index. Therein lays one of the clues to the sector’s appeal. The Healthcare Sector now represents 13% of the MSCI World Index – the same weight as Technology.
The sector is not homogenous. Over half of the sector sits in the Pharmaceutical bucket. Many of these companies benefit from prodigious cash flows which can fund dividends and share buybacks that attract bond market refugees. More recently, these businesses have undertaken or attempted corporate restructuring which has attracted another group of investors – those that are drawn to “events”.
Elsewhere in the sector, we enter the world of Biotechnology, Medical Devices and Life Science Tools; favoured hunting grounds for the committed growth investor, who must sift what are often binary business outcomes to lure the investor who likes a good story. The pace of technological change has accelerated in recent years with some commentators arguing that we are on the cusp of a technological revolution which will have profound implications for all industries and possibly the capital market system itself. This is the type of environment in which forecasts for revenues and profits can become wildly optimistic.
While price tells us that the sector has become popular, and has given the early adopters the means to fund their ceramic joints, zimmers and implants, we must look to valuation to provide some guidance around future prospects. A simple assessment of multiples reveals that the broad sector offers a dividend yield of 1.7% and a ROE of 16%, for which we must pay 4 times book or 24 times earnings. Expectations may not be as stretched as the ’98 – ’00 period, but on this basis, Healthcare is the most expensive of the global sectors.
If you discount the income stream of these stocks, you find that, on a forward looking basis, which is what all investors should be concerned with, Healthcare will be an unhealthy place to be. Time for a check up.