Healthcare Stocks: 2 To Buy, 1 To Avoid

Investors traditionally think of healthcare stocks as being highly defensive, due to the old adage: medical care is always needed, even in a bad economy.  In recent years, though, the sector has become more cyclical as more biotech companies have joined the traditional staple of pharmaceutical stocks.  While many cry that healthcare isn’t the ‘safety net’ it once was, these newcomers do increase the growth options that investors have at their disposal.  Over the past year, the sector as a whole has gained 13.6 percent, being outgained by only consumer defensive and technology stocks.

One pharma company that has outperformed its peers during this time period is Allergan, Inc. (NYSE: AGN), returning almost 17 percent.  This is not your typical healthcare stock, as the company’s primary focus is on tending to the needs of the ‘cosmetically challenged’.  AGN is the manufacturer of Botox, which accounts for 83 percent of total revenues.  In recent years, the company has fared well from the ‘Botox boom’, which is a term used to describe a worldwide expansion of discretionary spending on beautifying products.  In fact, AGN has noted that sales of Botox, dermal fillers, and breast aesthetics have increased 17 percent since last spring.  Moreover, recent FDA approvals now allow Botox to be used to treat chronic migraines, spinal chord injuries, and multiple sclerosis-related health problems.

The company’s executives are applauding this decision, as around half of all Botox usage is for therapeutic purposes, so these approvals should have a meaningful effect on AGN’s bottom line.  Over the past 5 years, revenues have grown at a compound annual growth rate of 12.1 percent, which is quite splendid considering its closest competitors are in the single digits.  Moreover, EPS has grown by an astounding 87 percent during this same period.  AGN currently pays a small dividend with a yield of 0.2 percent, though this high EPS growth signifies that yields may rise in the future.  Moreover, the company holds hardly any debt – with a D/E ratio of 0.3 – in an industry where many firms are indebted 2-3 times their equity.  Large hedge fund managers like Jacob Gottlieb and Michael Karsch are long AGN.  These details coupled with the fact that the company recently released impressive earnings – Q1 profits rose 45 percent – means that now may be the best time to get into AGN.

Warren Buffett

Essentially the polar opposite of AGN, Johnson & Johnson (NYSE: JNJ) is the world’s most diversified healthcare company.  A leading producer of everything from Band-Aids to baby powder, it seemed that this company hit a pretty hard wall of saturation, as annual revenues lay stagnant near $62 billion between 2007 and 2010.  Surprisingly, JNJ grew its revenues by 6 percent last year; this was a result of a spike in demand from BRIC nations, and the company’s acquisition of the vaccine biotech Crucell NV.  Shares of JNJ seem to be slightly overvalued at the moment, as its current P/E (18.7X) is above its 10-year historical average of 18.1X.  P/B and P/CF ratios tell a similar story.  With its new CEO Alex Gorsky taking reins of JNJ last week, the stock has risen to over $65 dollars a share.  Adding icing to its proverbial cake, the company also pays out a nice dividend yield of 3.5 percent. Hedge funds love this stock, as moguls Warren Buffett and Ken Fisher currently hold it.  If all of these reasons fail to convince you on JNJ, the track records of these two managers should garner your faith.

A member of “Big Pharma,” Bristol-Myers Squibb (NYSE: BMY) is a different animal than JNJ or AGN.  The company primarily researches, develops, and sells pharmaceutical drugs for a wide range of disorders and diseases.  In contrast to many of its competitors, it has exited general healthcare businesses to take a greater focus on its in-house drug development.  Over the past three years, shares of BMY have jumped almost 75 percent, as the company displayed a strong collection of drugs like Plavix and Abilify, though both drugs lose their patents later this year.  Additionally, it is projected that every single one of the drugs in BMY’s pipeline will lose exclusivity by 2017; a date that is sooner than almost all other mega-caps in the healthcare sector.  If this long-term danger wasn’t enough, slow revenue growth and overvaluation indicators do not motivate investors to buy BMY in the short to intermediate-terms either.  The company’s 3-year average revenue growth (6.2%) is below the industry average of 6.9 percent, while its P/E (14.9X) and P/CF (12.0X) ratios are both higher than the industry mark.  If that wasn’t enough, hedge funds have a particular distaste for JNJ stock.  Of the eight managers who currently hold at least 2 percent of their portfolios in JNJ, 6 elected to downsize their holdings rather significantly.  Some of these managers include Buffett, Kerr Neilson, and John Osterweis.

To make a profit off of these three stocks, investors can use pairs trading, by going long AGN/short BMY or long JNJ/short BMY.  While some may disagree on which strategy to use, most can agree on the fact that BMY is the worst stock of the three.

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