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inside the market

I've recommended U.S. health-care stocks on numerous occasions in the belief that developed world demographics made revenue growth virtually bulletproof in many instances. The sector as a whole has outperformed the S&P 500 by leaps and bounds over the past five years, but a recent sharp sell-off has left some prominent health-care names on sale – trading at attractive valuation levels relative to historical averages.

The S&P health-care index has skidded 11.5 per cent lower since the 2015 peak on July 20. Even so, the sector has drastically outperformed the S&P 500 over the past five years.

Consider three hypothetical investments of $10,000 (Canadian) in each of: U.S. health-care stocks, the S&P 500 and the S&P/TSX composite index beginning in October of 2010. Health-care stocks generated an average compound return of 22.9 per cent a year, which outdistanced the S&P 500's 17.1 per cent a year. In money terms, the hypothetical health-care investment would have generated more than $6,000 (again, in Canadian dollars) in excess profit over the U.S. equity benchmark. Sadly, the Canadian equity market is virtually flat for the period with a cumulative return of approximately one half of a percentage point.

My search for individual health-care stocks trading at attractive valuation levels after the sell-off began by comparing the current price to earnings (P/E) and enterprise value to earnings before interest, taxation, depreciation and amortization (EV/EBITDA) ratios of each health-care company against their respective five-year averages.

The results are posted in the accompanying table, ranked by largest discounts to price-earnings history. The screen is intended as a starting point for further research and the table on its own is not a sufficient basis for investment.

Hospital care provider Tenet Healthcare is currently trading with a price-earnings ratio about half of its five-year average after dropping 39 per cent in recent weeks. In terms of EV/EBITDA (which is used because it includes an adjustment for balance sheet debt load) Tenet is actually trading at a 10-per-cent premium to the historical average.

Gilead Sciences Inc., a biotech pharmaceutical, is trading at a discount both in terms of price-earnings and EV/EBITDA. The company's Hepatitis C treatment is in stiff competition from competitors, which might help explain the 47-per-cent valuation discount. Fellow biotech Alexion Pharmaceuticals held up well in the sell-off but the exorbitant price-earnings ratio above 50 times is prohibitive for many investors.

Investors looking for non-drug stocks in the health-care sector can look to Cerner Corp., which provides logistics solutions for medical offices and patients, and Express Scripts Holding Co., another logistics company focusing on software.

Health-care stocks were very hot for a very long time and investors should be cautious about being too aggressive buying them during the current period of volatility. Over the mid term however, and despite regulatory risks, the sector remains among the world's most promising for patient investors.

Follow Scott Barlow on Twitter @SBarlow_ROB.