The best health care stocks for 2020 and beyond to grow your portfolio
Health care stocks have been getting hammered lately but that might mean it’s the perfect time to buy.
I’ve screened through the two-thousand plus names in the sector to find five that should be on every investor’s radar for 2020. I’ll not only show you those best healthcare stocks to buy but reveal why this entire group of stocks could be ready to explode.
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Why You Need Stocks in Different Sectors
Today is part four in our series on the best stocks to buy from each sector in 2020 and I’m excited about this one. Today we get into one of the big universal forces I’ve been following for more than a decade, first as an economist and then as an equity analyst.
Not only will health care stocks benefit from an aging population, that big picture trend, but this is going to be one of the best safety sectors you can buy.
So what I want to do is going to be a little different from our previous sector investing videos. Instead of talking about how I picked these five health care stocks to buy, I’m first going to cover the big catalysts for the sector and a strategy for getting the most from the group. I’ll then reveal my five top stocks in health care and why I think they should go in your long-term portfolio.
I’m loving this series, covering the best stocks in each sector and it’s something so important but that most investors just don’t realize. Creating a portfolio that not only beats the market but is also diversified away from the biggest market risks means finding those best of breed companies from each sector.
You can’t just leave this up to chance, trying to find the best stocks to buy and hoping you’re diversified across sectors, it has to be a strategic effort. So over these 11 episodes, one for each stock sector, I’ll show you how to pick the best of breed in each.
Very important here, since we’re not covering how I picked these stocks like we usually do, make sure you check out that first video in the series. In it, not only do I highlight some great tech stocks to buy, I detail the criteria I’m using to find stocks across the entire series.
What is the Health Care Sector?
Here’s that graphic again and today we’re looking at the health care sector including drug stocks, biotech, medical services and equipment.
Comparing the sector performance here we see that health care has lagged four of the 11 sectors and the market in the five-year period with a 40% return and has actually only produced a 4% return over the last year, lagging every sector except energy stocks.
So it seems the sector had a real breakout period from 2012 through 2015 where it outperformed the market but it’s lagged ever since. That’s not necessarily a bad thing as it actually means health care stocks aren’t as expensive as the rest of the market.
If you look at the sectors on a price-to-earnings basis, so how much investors are paying for those earnings per share, we see that health care is the second least-expensive after financials. Health care stocks are trading for 14.8-times analyst expectations for earnings, that’s the dark-blue bar. If you look at the green bar, the 10-year average multiple for the sector is 14.3-times.
That means stocks in the group are only trading at 3.5% more expensive compared to that longer-term average which is really nice considering some of these other sectors like tech trading for 31% over its average and the market itself at 14% more than its long-term average.
Why Invest in Health Care Stocks?
Besides that fundamental reason to look at the sector, you’ve got a group of stocks with a stable revenue stream and pricing power. Inflation in health care costs have grown at 3.4% annually over the last two decades against just 2.1% growth in overall inflation and it’s that universal force of an aging population.
Over 10,000 baby boomers are reaching 65 years old every single day and that trend is going to continue until 2029. They’re moving into an age group that spends twice the amount on prescription drugs, hospital services and other healthcare costs.
Now of course, the big overhang on health care has always been regulation, or the threat of it by Washington. I’m not going to get into a debate about the cost or price controls. I’m here to help you make money, not to put together a perfect society.
Regulation is always going to be a threat to profits for companies in the space and it’s something you need to watch but it’s also something these companies manage every single day. Instead of worrying about what might be passed, focus on finding the best of breed companies in their industry, the best management teams running these companies, and let them worry about regulation.
Health Care ETFs to Buy
Now I want to reveal those five best health care stocks to buy but first lets look at three exchange traded funds, three ETFs, you can buy to get broad exposure to the sector. Use these if you can’t find individual companies you want to buy so you get that broader exposure for your portfolio.
First we’ve got the Health Care Select Sector SPDR Fund, ticker XLV, with its 1.6% dividend yield and super-low 0.13% expense ratio. The fund is pretty well diversified across industries in the sector so it’s going to give you that overall investment.
Health care is an extremely diverse sector with growth industries like biotech and more stable companies in services. Getting exactly the theme you want might mean looking for a fund that covers or excludes a specific industry.
So maybe if you want that growth part of health care, you go with the iShares Nasdaq Biotechnology fund, ticker IBB. This one is more expensive with an expense ratio of 0.47% and doesn’t pay much of a dividend at all but the idea is you get faster growth and the fund has produced a 14% annualized return over the last decade so it might be something to watch.
Or conversely, if you want a more stable return and want health care without the volatile biotech group, you can go with something like the iShares US Healthcare Providers, ticker IHF. This one is also slightly more expensive with a 0.43% expense ratio but has an excellent 4% dividend yield and has produced a 15% annual return over the last decade. The fund is split among the more stable industries in the sector like managed health care, services and facilities so you shouldn’t get the big ups-and-downs you see in biotech.
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Top Health Care Stocks to Buy Now
Now let’s look at the five stocks I’ve found that should be on everyone’s radar and what I’ve tried to do here is look for best of breed companies across the industries in health care. I want to give you ideas across the whole sector so we’ve got some drug makers and distributors, a biotech name, a services company and one in the retail consumer segment.
CVS Health, ticker CVS, has gone nowhere this year but if you want one company that represents almost the entire health care sector, this is it. Between the 9,800 retail pharmacies, insurance under the Aetna acquisition, a PBM and managed care organization, this company controls just about every step in the healthcare chain except drug making.
Being able to control almost that entire supply chain from discounts on buying pharmaceuticals to the patient experience, that advantage helps CVS control costs and customers like no other company.
Shares trade for just 9.5-times earnings which is a welcome change after some of the other sectors we’ve covered with shares topping 20-times earnings and higher. Analysts expect earnings to be slightly lower over the next year but given management’s ability to consistently beat expectations, I think EPS will come out flat at around $7.50 per share over the next four quarters.
Now as you’re thinking about any of these health care stocks but especially CVS, understand the rhetoric is going to get hot and heavy the closer we get to the 2020 election. Healthcare is a hot button issue and railing against company profits always plays well with voters.
It’s going to happen from both sides but I’d look at any news-related dips as buying opportunities. Just look at what regulation has changed in the past, pretty much nothing, and I don’t think we have too much to worry about for the near future.
CVS is well covered with 13 analysts providing price targets here. We’ve got a low target of $63 a share which is slightly below the current price and a high of $91 per share for around a 35% gain.
Merck, ticker MRK, is one of the most diversified drug makers in the sector with a strong pipeline of drugs in heart disease, cancer, a vaccine business and even sales in the animal-health space.
This is a $212 billion company with operating cash flow of almost $11 billion a year. The scale and cash power here is unmatched by just about any other drug maker which is hugely important when you consider an average of $800 million to bring a big drug to market.
Merck has a cash flow opportunity with its Keytruda and Lynparza blockbusters and is using almost $15 billion a year to buy back shares and pay out the dividend. Shares trade for 16-times earnings but look at the blowout third quarter they just announced. Merck beat earnings expectations by 21% over the quarter. Earnings are only expected 2.5% higher over the next four quarters but given management’s history, we could see the actual number much higher than the $5.23 per share expected.
Merck has largely missed the opioid litigation against many of the other drug makers so it could have the opportunity to really speed ahead in some key drug segments while competitors are facing uncertainty in the courts. Analysts have a low target of $89 a share which is just above the current price and a high target of $105 each which would be a 26% return on the shares.
At $26 billion in market cap, Mckesson is the world’s largest pharmaceutical and medical supply distributor in the world. For example, with Merck you’ve got a drug maker and with CVS you’ve got a retail pharmacy. McKesson is the company that sits in-between the two, negotiating lower prices with Merck and selling to CVS.
Between the three distributors; McKesson, AmerisourceBergen and Cardinal Health, these three companies control over 90% of the distribution business globally. What I like about McKesson is that it also has its own retail pharmacies and an IT infrastructure that helps it manage the supply chain better than the other two competitors.
Now of course, this controlling status over pricing between pharmacies and drug makers puts McKesson and its two peers right in the middle of any fight over drug prices. It’s unavoidable and there will bound to be ups-and-downs whenever the issue comes up. The group has been working through a major settlement over the opioid crisis and has enough financial flexibility to negotiate any drug pricing legislation.
Shares trade for 9.7-times earnings which are expected higher by 5.8% over the next year. Not a huge move but stable and I think just clearing out some of the uncertainty around the opioid litigation will be enough to send shares higher.
Analysts see the shares at a low around $135 over the next year or as high as $169 per share which would be a return of 25% over the period.
UnitedHealth Group, ticker UNH, is the largest private health insurer in the U.S. as well as a strong business line internationally.
The company insures 50 million members covering 15% of the insured population. That puts it well above the next largest rival with just 10% of the market. Combine this scale with a strong health information technology business and a pharmacy benefits manager to negotiate costs and you’ve got a business model that can’t be beat.
In fact, the CVS/Aetna and Cigna/Express Scripts mergers over the last several years were both an attempt to copy the UnitedHealth business model.
Shares trade for 17.3-times earnings, so a little more expensive than other stocks on the list but maybe worth it on that remarkably stable earnings growth. Earnings are expected almost 11% higher over the next year and will likely be much higher considering management’s history of beating estimates.
This is another one that could be uncharacteristically volatile around headlines going into the 2020 elections but where the dips could be a buying opportunity. For all the talk around government-paid health coverage, nobody has a workable plan or a way to pay for it that can get through Congress.
Analysts have a low target around $257 per share over the next year with a high at $310 a share which would be 24% from the current price.
Gilead Sciences, ticker GILD, is another solid stock in the drug maker space with a 4% dividend that beats most others.
Gilead is a leader in drugs treating HIV and Hepatitis, two of the highest profit margin markets in drug-making. In fact, Gilead is so successful in HIV treatments that it serves 80% of the patients in the United States.
Shares trade for 9.7-times earnings on a PE basis with earnings expected 4.6% higher over the next year. Now that first and fourth quarter, the next two to be reported, have historically been weak for Gilead so you might buy half of your investment now and wait to see if shares fall on a bad earnings release when those reports come out.
Analysts have a low target at $66 a share, right where the stock is now, and a high target of $95 per share or 45% higher than the current trade.
Health care stocks may not be the cheapest in the market but the sector is one of the best long-term investments you can make. Healthcare has lagged the market for the last couple of years but that might make it the perfect time to buy some of these safety stocks.