Health Care Sector Rating: Outperform


Health care sector overview

In general, health care companies' balance sheets are solid, their stocks have offered attractive dividend yields and the sector's overall cost structure appears to have improved. Demand appears to be on the rise for health care products and services. On the other hand, political rhetoric around the Affordable Care Act can be expected to fuel continued volatility.

Market outlook for the health care sector

The health care sector has taken a couple of hits lately. Amazon, JPMorgan and Berkshire Hathaway announced that they are joining forces to address the rising cost of health care, while the President again mentioned the price of drugs in his State of the Union address.  We won’t discount the first issue, but there were no details given and we’ve heard this song before.  And we believe if they are able to lower costs, it will be in concert with working with the broader industry—benefitting the entire group.  As for the fears of drug price controls, we continue to believe that’s a non-starter as long the Republicans control Congress—so we believe the recent pullback is a potential  opportunity to get into the group.

In our view the health care sector has a lot of positives going for it and has had decent performance over the past year—but we think there’s improving performance to come. Valuations appear fair to slightly below average, balance sheets are solid, stocks generally have good dividend yields, and the overall cost structure appears to be much improved. Also, demand appears to be on the rise for health care products and services, partly as a result of an aging population

The Affordable Care Act continues to be a potential source of volatility for the sector, but we believe this creates potential opportunities for investors and are currently rating the group at outperform. While a broad-based repeal seems highly unlikely in the near-term, there are smaller changes being made administratively and proposed legislatively will likely continue to result in ebbs and flows in the sector as investors tried to gauge the impact on various areas of the sector. This is a story that will continue to develop over the next several months, at least. This will likely keep the health care sector a bit more volatile than usual, but also create some opportunities for investors willing to ride the potential roller coaster. Another factor potentially helping the group, the Federal Reserve continues to raise rates and—according to BCA Research—the sector has outperformed during Fed hiking cycles on average since 1970. Since past performance does not guarantee future results, we acknowledge that there are risks and it could be a bit of a bumpy ride, but we believe that brighter prospects are ahead and remain comfortable with our outperform rating on the group.

We believe an outperform rating for the entire sector is appropriate, although at times it will feel disappointing as the sector experiences both short-term dips on speculation as to what changes may or may not occur, but we urge investors to remain patient and ride out these short-term potential storms.

Factors that may affect the health care sector

Positive factors for the health care sector include:

  • Increased need for services: An aging population requires more extensive drug treatments and medical care. The health issues associated with obesity also could boost demand for medical services.
  • Strong financials: Balance sheets in the health care sector remain flush with cash, increasing the possibility of higher dividend payments, share-enhancing stock buybacks, and mergers and acquisitions.

Negative factors for the health care sector include:

  • Regulatory uncertainty: Despite the elevated rancor in Washington and Republican to this point unable to agree on a way forward, the ACA and other health care-related policies still seem likely to change at least somewhat, but what those changes may be are virtually unknowable at this point.
  • Fiscal policy concerns: The current fiscal situation in Washington creates uncertainty regarding the health care sector. Medicare reimbursement rates, for example, could be changed due to budget issues.

Clients can see our top-rated stocks in the health care sector.

Want to learn more about a specific sector?  Click on a link below for more information or visit Schwab Sector Views to see how they compare.

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