What are we looking for?
Undervalued U.S. health-care stocks with upside potential.
The U.S. health-care sector has underperformed the broad market with the Health Care Select Sector SPDR ETF (XLV) rising just 3.7 per cent year-to-date. By comparison, the Technology Select Sector SPDR ETF (XLK) has returned an impressive 24 per cent.
Over the past week, however, our North American research desk has noticed a rotation out of financial and information technology stocks into health-care stocks. Notably, stocks in the medical supplies industry have started to rebound, helping to lift the overall health-care sector. We are starting to see some health-care companies showing better value when compared both with their industry peers and S&P 500 stocks generally.
We will be using Trading Central Strategy Builder to search for U.S. health-care stocks with below average valuations and a history of positive earnings growth.
We begin by setting a minimum market capitalization threshold of US$5-billion to focus on larger, more stable and established companies in the sector. Next, we will look for companies that are currently reasonably valued based on their price-to-earnings ratios. The S&P 500 health-care sector has a current P/E of 21.5, which is above that of the S&P 500 at 18.9. We will select only stocks with P/Es below 18.9 in order to find health-care stocks with the best value. We will also look for stocks that have had positive average annual earnings growth over the past five years.
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What we found
Topping our list is health-care plan provider Molina Healthcare Inc., which focuses on Medicaid-related services for low-income families and individuals. The stock declined 24 per cent in April after political headwinds emerged related to a possible “Medicare for all” insurance plan, which scared off investors before the stock rebounded 15 per cent. Molina has displayed impressive EPS average annual growth of 56.5 per cent over the past five years with a current P/E of 10.6, which stands well below the industry average.
Celgene Corp., a biopharmaceutical firm that discovers, develops and markets therapeutics for the treatment of cancer and immunological diseases, made the list with an impressive P/E of 14.6 and five-year average annual EPS growth of 26.8 per cent. Price action just broke above September highs of US$94, which was a key resistance area that has been watched closely by technical analysts.
The largest company on our list is UnitedHealth Group Inc., which also happens to be the largest private health-insurance provider in the United States. The current P/E is 18.5 and UnitedHealth has maintained solid average annual EPS growth of 17.3 per cent over the past five years. Its share price declined more than 23 per cent this year before posting an impressive 10-per-cent rebound this month.
Trading Central Strategy Builder provides a back-testing capability to evaluate how well an investing strategy would have worked in the past. Using a five-year historical period with quarterly rebalancing, the screen described had an annualized return of 11 per cent compared with 9.4 per cent for the S&P 500.
The investment ideas presented here are for information only. They do not constitute advice or a recommendation by Trading Central in respect of the investment in financial instruments. Investors should conduct further research before investing.
Gary Christie is head of North American research at Trading Central.