The InvestMentor

March 26, 2002

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In my next life, I’m going to be a doctor. There is nothing cooler than the act of human repair and it’s as close to godliness as man gets. I’m a junkie for TLC’s "Trauma, Life in the ER." Were it not for an extensive education in Finance and all—and a penchant for fainting around needles—I might have gone down that path. Well, it was really about the needles. My wife’s recent epidural nearly made me drop like a sack of wheat.

So I confine my involvement in the healthcare field to the vicarious: investments in each of the four groups of investment opportunities. They are Pharmaceuticals, Biotechs, Medical Devices/Supplies, and Healthcare Services. I try to own at least one name from each area, valuations permitting.

The important thing about investing in healthcare, at this stage of the market, is that you don’t get too defensive. That is, traditionally many healthcare stocks are seen as defensive—they do well in a falling market. The rationale is that the earnings cycles of healthcare companies are immune to recession. People need their meds in good times and bad. For example, drug companies have done well in the bear market because they’ve delivered consistent growth. But often these types of stocks are discarded when the market is on the rise.

Thus, as you look healthcare stocks, I’d encourage you to ferret out the counter-market names. Specifically, compare the charts of prospective ideas to the overall market and avoid those that seem to move inversely.

The Pharmaceutical world is as difficult to understand now as it ever was. There are thousands of drugs coming to market each year, and it’s hard to gauge their revenue potential in advance. Which is to say nothing about the most important trend to hit the sector—generic drug makers. The generic makers are winning daily battles in the patent breakdown area, and engulfing market share from the branded drugs. However, generic makers have much lower margins than their branded counterparts. Nevertheless, I think generic pharmas are the way to play the drug group.

Biotech, more than the other three healthcare sectors, is truly an island unto itself. Biotechs are nobody’s version of defensive, and often represent an all or nothing investment, typically tied to the FDA approval of one drug. Thankfully, there are a few biotechs that have positive earnings from a previously approved compound. They use that cash flow to fund research in future products. These are where I prefer to confine my search.

In the Devices area, as mentioned last week, the problem is that everybody knows how sexy this field is. As I mentioned last week, all the really good, fast growers, are trading at exorbitant multiples. A good year of broad market recover may take focus off this group, and bring down their valuations. But in the meantime, it’s one group I have to take a pass on.

Finally, there is Healthcare Services. This covers a broad range of companies from assisted living centers and outsourced caregivers to consulting and laboratory service companies. In the latter area, I have long since admired Laboratory Corp (LH). Lab Corp is an independent clinical laboratory for the medical community that provides testing, diagnosis, and monitoring and treatment of disease. The stock has not taken a break in years, but the valuations are remarkably reasonable. They trade at a forward P/E of 24 and when compared with their forecasted growth rate of 25%, you get a PEG (P/E to Growth) of below one.