Feeling Better about Health Care

Given current low valuations and an improving outlook, S&P is raising its portfolio weighting for the sector's stocks

By Robert Gold

Until very recently, the health-care sector was ranked among the market's most depressed areas. The poor performance largely reflected selling pressure in the pharmaceutical and biotechnology groups, which offset strength in facilities and managed care. But in the last two weeks, the sector has staged a sharp recovery. Year-to-date through July 26, the S&P Health Care Index was down 24.9%, vs. a 25.7% decline in the S&P 500-stock index.

At present valuation levels, and on the expectation of more realistic revenue and earnings growth expectations and improved industry news, we at S&P have raised our sector recommendation for health care to marketweight from underweight. A marketweight recommendation means investors should have the same exposure to the sector as the amount represented in the S&P 1500 Super Composite index. (Health-care companies represent 14.2% of the index.)

Among the various health-care segments, medical technology stocks should perform well in the second half of 2002 and into 2003, aided by new-product approvals in areas like cardiology, orthopedics, and diagnostics. The revenue outlook has benefited from favorable swings in the euro and yen relative to the U.S. dollar. S&P is looking for industry revenue growth of 13% to 14% in 2002, with margin expansion driving average earnings in the high-teens area.


  In biotech, recent drug approvals and more reasonable valuations should allow stocks in this group to recapture some lost ground. However, we're concerned about the continued absence of a Food & Drug Administration commissioner. Biotech stock prices will almost certainly remain volatile and are recommended only for aggressive investors.

Meanwhile, pharmaceutical shares have suffered from slowing growth rates amid heightened competition in key therapeutic categories, longer FDA product-review times, and a flood of generic drugs on the market. In addition, the new-product pipelines appear anemic, with few clear blockbusters on the near-term horizon.

But with valuations at six-year lows and merger activity appearing ready to accelerate, we've become more constructive on the pharmaceutical group and expect that it will begin to generate returns similar to the broader market.


  The outlook for hospital and HMO stocks is bullish, and recent actions by Congress support the contention that federal reimbursement rates to providers will not be lowered in the foreseeable future. In many cases, however, valuations are at historic highs.

S&P's current favorites include Tenet Healthcare (THC ), St. Jude Medical (STJ ), Cephalon (CEPH ), Steris (STE ), Guidant (GDT ), and UnitedHealth Group (UNH ), all of which carry S&P's highest investment ranking of 5 STARS (buy).

Analyst Gold follows health-care stocks for Standard & Poor's

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