From looking at the charts of major healthcare stocks, you would think that their last earnings reports were just dreadful, but as it turns out, they were one of the best-performing sectors fundamentally. So why are investors are so bearish on healthcare stocks? Analysts have a few ideas and see a buying opportunity based on the recent weakness.
S&P 500 gets killed in August
Last month was an atrocious one for the S&P 500 Index as a whole, as all of its sectors were burned. Overall, the index fell 6.3%, with healthcare stocks taking an 8.1% hit during the month, the largest of all the sectors in the S&P 500. It was a major diversion from the traditional investing view that price will lead fundamentals, notes S&P Capital IQ Senior Analyst Lindsey Bell. She doesn’t believe the recent pullback in healthcare stocks is justified.
The Healthcare sector as a whole performed magnificently during the second quarter, unlike its Energy and Materials counterparts. In fact, Healthcare posted a growth rate of 14.7%, which significantly outperformed that of all the other sectors.
The market bottomed out on Aug. 25 with a 10.3% correction, according to Bell. Since then, healthcare stocks have recovered some of the value they lost last month, but they still have a long way to go as they’ve only recovered halfway, leaving potential opportunities for value investors.
Healthcare sector the fourth worst-performing
Bell analyzed the price performances for the various sectors in the S&P 500 and found that Healthcare was the fourth worst behind Energy, Materials and Financials during the second quarter earnings reporting period between July 13 and Sept. 11.
She noted that Healthcare beat the initial consensus estimates by 861 basis points, the largest beat of all the sectors.
It’s unsurprising that Energy and Materials were the worst laggards because commodity prices have been volatile and both sectors have struggled all year. Also Financials are being affected by the Federal Reserve’s inability to decide when to raise interest rates, leaving a lot of uncertainty across the sector.
Healthcare stocks’ multiple low
Also healthcare stocks are trading at a multiple of 16.8 times, Bell also points out, a discount from the 15-year average of 17.1 times. Also she notes that this recent multiple is the lowest of the year.
Healthcare outlook remains strong
Further, Bell notes that in other sectors, weakness was driven by soft outlooks, but that isn’t the case with the Healthcare sector. Management commentary from most companies in the sector indicated that their fundamentals remain strong. The analyst said higher enrollments, better management of costs, and growth in prescription drug sales are boosting fundamentals across the Healthcare sector, and she expects these factors will continue to boost earnings growth this year, possibly by as much as 12.9%.
Earnings growth in the Healthcare sector has been one of the main drivers for overall earnings growth in recent quarters, Bell added. She said the sector posted growth in the double digits for each of the previous five quarters. In last year’s fourth quarter and this year’s first quarter, the growth rate was higher than 20%.
The analyst suggested that the recent pullback in Healthcare stocks may be due to widespread profit taking as investors started to worry that China’s economic problems would spill over into other global markets.
What about biotechnology stocks?
The Biotechnology subsector has been in the spotlight recently, and Bell believes that before the pullback, the sector had a reasonable valuation because it posted the best growth of all subsectors. Then this week a new bit of bad news. Presidential candidate Hillary Clinton and others have started talking about restricting drug price increases, and their comments have sent ripples throughout biotech stocks. However, analysts are skeptical that any such restrictions will actually pass.
“Similar investigations and proposals have been made in the past, and that resulted in minimal impact to the industry, Bell told ValueWalk in an email. “Near term, headline risk will remain as it will be an easy target during for the presidential race. That said, we believe passing price caps in a Republican controlled Congress is unlikely.”
Citi analyst Liav Abraham agrees, at least in the near term. She notes that any move to restrict drug price increases would probably require an act of Congress and that Republican control probably means it won’t happen. However, Oppenheimer analyst Akiva Felt warned against completely dismissing drug price increases, adding that there could end up being bipartisan calls for more controls.
All charts and graphs in this article are courtesy S&P Capital IQ.