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The healthcare industry offers many attractive features, probably the most important of which is the demographic background. The aging populations of the wealthy developed economies is increasing demand for the products and services the sector provides. The outbreak of the Covid-19 pandemic in 2020 and the rapid development of vaccines to counteract its effects also demonstrated the remarkable resources that scientific advances have made available to pharmaceutical and medical companies. For example, advances in treatments based on genomic research is a notable area of progress.
Given these developments, it’s surprising that pharmaceutical and healthcare equipment companies have not proven to be especially strong performers over the last few years.,The iShares Global Healthcare ETF (NYSE: IXJ) has delivered an average annual compounded rate of return of 7.5% since inception in November 2001 to March 31, 2023. Five- and 10-year returns were somewhat stronger, at slightly over 10% annualized, but still lagging the S&P 500 Composite with its 10-year annualized return of about 12%.
Given the high weight of technology stocks in the broader index, and the negative impact of patent expiries on the sales of major drugs for the large pharmaceutical companies, the longer-term underperformance becomes somewhat more explicable.
The pandemic highlighted the importance of medical science in dealing with threats to human health. The successful efforts by the major drug companies to provide effective vaccines in a punishingly short time frame demonstrated that the pharmaceutical industry is in the best position to benefit from changing attitudes towards it for many years.
With major patent expiries having occurred in the last few years, and with the development of new treatments using the mapping of the human genome by many biotechnology companies, the opportunity for large drug companies to enjoy a period of strong revenue growth is excellent. Any lack of success in their own research and development efforts can be offset by purchasing smaller biotech companies with interesting treatments at early stages of development.
The bear market of the last two years means that many of these early-stage companies are selling at very attractive valuations compared with long-term averages. With the example of the rapid introduction of Covid-19 vaccines, the probability of the regulators speeding up the approval of life saving treatments looks better than it has for many years. In addition, with the aging population in developed countries, chronic but non-fatal conditions such as hypertension, diabetes, and high cholesterol provide an attractive market for the pharmaceutical majors.
One of the attractions of healthcare as a sector is that the major companies are profitable and pay reasonable dividends to their shareholders. While the iShares Global Healthcare ETF has a trailing 12-month dividend yield of 1.2%, after an expense ratio of 0.4%, this reflects lower yields for a number of healthcare and pharmacy management companies in the index. This includes the largest holding, United Healthcare at 6.5% of the portfolio, Elevance Health, CVS, CSL, and Cigna, which tend to yield 1%-2%.
Pharmaceuticals generally have yields in the 2.7%-4% range, such as Johnson + Johnson, Merck, Abbvie, Pfizer, Novartis, Bristol Myers Squibb, Amgen, and Sanofi, all in the top 15 holdings of IXJ. This level of yield would be equivalent to over 40% of the total return from the sector since 2001, indicating how important income has been to providing a satisfactory return from this sector.
There has also been a wide dispersion in returns from the major companies in the sector, with the share prices of health and benefits management companies such as Unitedhealth and Elevance doubling over the last five years, while Eli Lilly’s focus on diabetes has seen its stock triple. However, many pharmaceutical stocks are up less than 25% over the same period, including such major players as Johnson + Johnson, Abbvie, Pfizer (despite its Covid-19 vaccine success), Novartis, Gilead, and GSK. This reflects patent expiries, class action lawsuits, and the lack of success by many companies’ research departments. The latter factor makes their need to buy promising new treatments from smaller companies all the more urgent.
Investment in the healthcare sector offers investors an attractive mixture of growth possibilities, decent balance sheets with many companies being rated AA or better, and a reasonable level of income. With aging populations in the developed countries and the consequent increase in demand for medical treatments, along with rising income levels in developing countries, the fundamental drivers for the sector are extremely attractive. Meanwhile, their effective response to the Covid-19 pandemic has radically improved the public perception of the industry, and may enable new medications to arrive on the market in a much more timely fashion. It’s difficult to think of another sector that possesses such attractive prospects.
Gavin Graham is Chief Strategy Officer of Calgary-based SmartBe Investments. He is a veteran financial analyst, money manager, and a specialist in international investing, with over 35 years’ experience in global investment management. This is an edited version of an article that originally appeared in the Jan. 30 issue of the Internet Wealth Builder newsletter.
Notes and Disclaimer
Content © 2023 by Gavin Graham. Used with permission.
The commentaries contained herein are provided as a general source of information, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.
The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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