Thursday, May 23, 2013

Taking the Pulse of Health Care Stocks

Even after yesterday's sell-off, investors in health care stocks (pharmaceutical, medical device and biotech) have enjoyed gains far in excess of the S&P 500 over the last 12 months.

In one respect, such strong outperformance is a little unusual, since health care is usually viewed as a defensive sector.

But we live in unusual times, and health care stocks have refused to follow the traditional script. Given the high dividend yields available on the big pharma stocks, and the anticipation of a surge in demand for health care with the passage of Obamacare, investors have flocked to the group, and the stocks have reacted accordingly.

Yesterday I had the chance to hear from Tim Anderson, who follows global pharmaceutical stocks for Bernstein. 

Tim - who is a doctor by training, and still is licensed to practice medicine - is one of the better analysts in the space, so I was looking forward to his thoughts.

In the 15 years that Tim has been following the group he has been largely neutral to bearish on his stocks, which turned out to be the correct call.

However, about 18 months ago he turned more optimistic as the two biggest negatives for pharma stocks over the past decade - lagging R&D productivity and large patent expirations - have gradually subsided.

In Tim's view, performance of pharma stocks is directly tied to the new drugs in their pipelines.  There seems to be more evidence that all of the major pharma companies have made significant gains in their R&D efforts, and new drugs with possible large revenue potential seem likely over the next few years.

Tim continues to like many of the pharma stocks he follows, but he is more favorable to European stocks (e.g. Novartis, Sanofi, Roche) than U.S. stocks since he anticipates better growth rates from the European companies.  Valuations are also slightly more attractive among the European group.  Still, he feels positive on both domestic and foreign companies.

Many investors have worried that pharma companies will experience more downward pressure on drug pricing as government influence in the health care system becomes more pervasive.  However, Tim finds this has not been the case.

Tim feels that his group will continue to act well so long as valuations relative to other "defensive" sector remains favorable, and dividend yield continues to be a focus of investors.