What to look for in healthcare stocks

Everyone requires healthcare services at some point in their life. Therefore, there exists a vast investment opportunity for individuals seeking to invest in this sector. Globally, healthcare expenditure amounts to approximately $8.3 trillion, with almost half of the amount, about $3.8 trillion, being spent in the United States. As the healthcare sector is growing at a much faster pace than the overall global economy, it is expected that the figures will be considerably higher by the end of the decade.

Investors seeking to profit from the growth in the healthcare sector can consider investing in healthcare stocks. The healthcare sector is diverse and includes various types of stocks. Four of the most important types include drug stocks, medical device stocks, payer stocks, and healthcare provider stocks. Drugmakers focus on developing drugs to prevent or treat diseases. Biotech companies use live organisms such as bacteria or enzymes to develop drugs, while pharmaceutical companies use chemicals. Medical device companies create devices used to care for patients, from disposable gloves and thermometers to artificial heart valves and robotic surgical systems. Payers, such as health insurers and pharmacy benefit managers, play a significant role in the U.S. healthcare system, charging premiums to cover healthcare costs or administering prescription drug benefits. Healthcare providers are responsible for delivering healthcare services to patients and include hospitals, physician practices, home health companies, and long-term care facilities.

How to Identify Strong Healthcare Stocks: Four Key Considerations

Investors seeking to buy the best healthcare stocks should evaluate companies based on four key factors:

1. Growth prospects The most critical aspect to evaluate is a healthcare company’s growth prospects. Investors should assess the speed at which the company’s revenue has grown in recent years and explore its plans for future growth. They should review the company’s investor presentations and regulatory filings, which often mention competitors and potential markets. Additionally, investors should consider the potential impact of mergers and acquisitions on a company’s growth.
2. Financial strength Investors should also evaluate a healthcare company’s financial strength by reviewing its financial statements, particularly its cash position and free cash flow. A strong cash position and high free cash flow indicate a company has the financial capacity to weather economic downturns and pursue growth opportunities.
3. Valuation Valuing a healthcare stock is important to ensure investors are paying a fair price. The price-to-earnings (P/E) ratio, a popular valuation metric, can be forward-looking or backward-looking. Investors should also consider the price-to-earnings-to-growth (PEG) ratio, which incorporates projected earnings growth rates. Comparing these ratios with industry peers can help investors determine if a stock is undervalued or overvalued.
4. Dividends Investors should consider whether a healthcare company pays dividends, which can increase overall returns. They should evaluate the dividend yield, which measures the size of annual dividend payments relative to the share price, and the payout ratio, which measures dividends as a percentage of earnings and indicates the company’s ability to sustain dividend payments.

What are the risks associated with investing in healthcare stocks? Investing in any kind of stock entails risks, including the potential for competitors to develop more successful products or services. Healthcare stocks face these risks as well as others unique to the sector.

The healthcare industry is subject to heavy regulation. Manufacturers of drugs and medical devices can fail to secure regulatory approval for new products, and regulatory changes can significantly affect the growth prospects of healthcare stocks. In the United States, the Food and Drug Administration (FDA) regulates drugs and medical devices, and it is prudent to monitor any FDA actions related to medical stocks under consideration.

Furthermore, many healthcare stocks face significant litigation risk. Biopharmaceutical companies, medical device makers, and healthcare providers can be sued if patients believe their products or services have caused harm.

In addition, drugmakers and medical device manufacturers must persuade payers, such as health insurers, pharmacy benefit managers (PBMs), and government agencies, to purchase their products. If these companies are unsuccessful in obtaining reimbursement approvals, their growth prospects may diminish.

Furthermore, many healthcare companies are heavily dependent on Medicare reimbursement levels, and upcoming changes to Medicare will allow the program to negotiate prices with drugmakers. As a result, some drugmakers’ revenues and profits may decline as Medicare pays less for certain drugs.

Despite these risks, the long-term outlook for healthcare stocks appears positive. Aging demographics worldwide, coupled with technological advancements, should create significant opportunities for healthcare stocks and produce healthy returns for patient investors.