Global health care is my favourite investment sector right now because it's largely immune from ongoing economic and interest rate-related anxieties. An aging developed world population means that, for the sector as a whole, revenue growth is virtually assured no matter what happens. Health-care stocks are not without risks – changing regulations are chief among them – but few if any other sectors can be as confident about growth.
The S&P 500 health-care index is now deeply oversold despite these rosy longer-term prospects, making this an ideal time to hunt for investor bargains. The index dropped 12.5 per cent between Aug. 1 and Nov. 1 and according to the relative strength index, or RSI (my favoured short-term technical indicator), the sector is firmly in buy territory.
To uncover individual equity opportunities in the sector, I went with a "safety first" methodology. The first step, adapted from Warren Buffett, was to rank all companies in the index by 10-year volatility of cash flow generation. The intention was to find the stocks representing the most consistent money-making machines, where cash flow growth that was most dependable in the past is more likely to continue into the future.
This process gave me a list of 12 stocks with extremely reliable cash flow. Next, I checked valuation levels for these stocks by comparing the current price-to-cash-flow ratio with the five-year average. Unfortunately, no screaming buys emerged in this section – all of these stocks are trading at price-to-cash-flow levels above their historical averages.
The stocks were also assessed for stock price and earnings growth, including five-year average annual earnings a share increases, and also the average analyst estimate as to the long-term profit growth.
The accompanying table summarizes the analysis with the stocks ranked by lowest volatility in cash flow generation within the S&P health-care index. In terms of highlights, Johnson & Johnson has the most bulletproof cash flow history but its long-term expected growth rate is among the lowest on the list. Pfizer Inc. is the most attractive to income investors, but risks that a new U.S. president will enforce drug price limits could be an issue for the company.
Quest Diagnostics Inc. is attractive relative to valuation history, and also boasts a remarkable 43 per cent average annual profit increase. Orthopedics provider Stryker Corp. and Becton Dickinson and Co. have also grown earnings at an impressive rate in the last five years.
Investors looking to swing for the fences – trying to find stocks with the highest upside – in the health-care sector will not find them on this table. The stock screen method, by emphasizing stability of cash flow, is biased against higher risk/higher return sectors like biotechnology. For investors looking to "get rich slow" with ultra-stable growth for the long term, however, the stocks listed on the table are a great place to start looking.
Scott Barlow, Globe Investor's in-house market strategist, writes exclusively for our subscribers at Inside the Market online. Subscribe to Globe Unlimited at globeandmail.com/globeunlimited.
Select U.S.-listed health care stocks
|Company||Symbol||CF Volatility Rank||P/CF||5Y Avg P/CF||5y Avg EPS Growth %||Est LT EPS Growth %||3Y Avg Ann TR %||Div. Yield %|
|Johnson & Johnson||JNJ-N||1||17.81||14.13||9.59||6.55||10.35||2.77|
|Quest Diagnostics Inc.||DGX-N||3||11.14||10.71||43.24||7.28||12.10||1.95|
|Eli Lilly & Co.||LLY-N||4||21.95||15.11||0.19||11.45||16.51||2.78|
|Lab. Corp. of America||LH-N||6||11.56||10.96||5.72||11.17||6.97||N/A|
|Becton Dickinson And Co.||BDX-N||7||14.10||11.94||87.13||11.28||18.56||1.57|
|Dentsply Sirona Inc.||XRAY-Q||8||21.23||14.98||1.85||9.76||7.96||0.51|
|Patterson Cos Inc.||PDCO-Q||9||53.88||18.14||3.19||7.69||2.93||2.12|
|Agilent Technologies Inc.||A-N||10||17.95||17.39||-15.35||10.43||7.04||1.06|
|Baxter International Inc.||BAX-N||12||19.94||11.72||N/A||12.36||11.91||1.10|