2 Health-Care Stocks for Times of Uncertainty

It is nearly impossible to time the markets. Since August, when we had the worst market crash since 2009, the market has been bouncing in a defined range like a Ping-Pong ball. While economists recheck the alignment of the planets to predict the next big move, most of us are simply tired of watching our portfolios oscillate between green and red every day. Although it's a difficult time for buy-and-hold investors, there are stocks that should hold up in their fundamentals, even if a global recession is headed our way.

Health-care stocks moving on up
Fear has induced a massive exodus from risky assets in the wake of the S&P downgrade. Since the health-care industry doesn't care about economic cycles, health-care stocks have been performing admirably. Abbott Labs (NYSE: ABT  ) , for instance, has been lifted far above its August lows of $46.29 a share. Investors have probably been chasing the stability of the company's earnings prospects, and of course the large dividend. The company has recently announced that it intends to split its pharmaceutical division into a new company while keeping the rest of the company under the Abbott name; more on that later.

In light of recent fears, Treasury bill yields have hit rock bottom, as European banks and money managers poured into the perceived safety of the dollar. The effect was extreme enough to cause negative yields on TIPS (fixed-income instruments designed to accommodate for inflation) in October. While T-bills are considered the safest and most liquid financial instruments available, their yields are absolutely terrible relative to dividend stocks. As small investors, we seldom need to worry about liquidity, because of the small size of our transactions. Since we trade in such tiny blocks, we won't affect the price of any large health-care stocks like Abbott. Besides, as buy-and-hold investors, we aren't looking to sell our shares unless there are fundamental changes.

Buying into Abbott gives you a 3.6% yield, which is a lot higher than any standard T-bill rate nowadays. The stocks of Abbott and the very similar Johnson & Johnson (NYSE: JNJ  ) , which also yields 3.6%, make up an ultrasafe dividend portfolio that significantly outperforms even 30-year T-bills in the long run.

Diversification makes them look even better
What makes these companies so safe? As I said, health-care stocks generally don't care about the economy. What makes Abbott Labs and Johnson & Johnson even better bets is that their product lines are very diverse. Not only do these companies sell pharmaceuticals, but they also have very strong presences in medical devices, consumer products, and diagnostics.

When a company like Pfizer (NYSE: PFE  ) develops drugs for its pipeline, the stakes are huge. Unfavorable results in clinical trials or strong FDA disapproval can terminate a drug's development, wasting all the money spent during development. Investors may be rewarded with a blockbuster drug, but even then, the patent expiration would ultimately bring generic competition (when a pharmaceutical company loses its patent, anyone can manufacture the compound). Lipitor, for instance, was an amazing development that still brings Pfizer $10 billion in annual revenue. But with the patent expiring this month, the gravy train will screech to a halt as generics drastically reduce Pfizer's pricing power for Lipitor.

Since Abbott and Johnson & Johnson derive much less revenue from their drug divisions, investors who aren't as keen on pipeline investing would be well-served by these companies. To put it in perspective, Pfizer and Merck (NYSE: MRK  ) earn about 85% of their revenue from their pharmaceuticals divisions. Abbott and Johnson & Johnson derive only 57% and 36%, respectively.

The full effects of Abbott's removal of its pharmaceutical division won't be known for quite some time, but I would argue that Abbott has the potential to become one of the, if not the, most stable and defensive health-care stock(s) on the market after the split. Abbott will be able to focus entirely on growth-oriented medical products without the financial drain of pharmaceutical development. While the dividend of the new "pharmaceutical-free" Abbott could end up being slightly lower, the relative safety of the company's earnings should compensate.

The split has a lot to do with whether two parts make a whole. What Abbott probably found out is that its pharmaceutical division would perform better if it were separated from Abbott, and vice versa for other divisions. When the company splits, Abbott shareholders will probably be awarded proportional stakes in the two new companies. You'll still be holding what is essentially the "old" Abbott, but it will have two tickers and they might even be more efficient. Your investment decision shouldn't be drastically affected by the news. Nonetheless, if you want to avoid any controversy behind company splits and potential dividend changes, you can simply stick with shares of Johnson & Johnson.

And there's plenty of room to grow
Just because Abbott and Johnson & Johnson don't undertake as much risk as other health-care giants doesn't mean that shareholders won't see impressive growth in revenues. As our population ages, the Bureau of Labor Statistics and other research institutions expect medical professions to experience massive growth in the coming decade. There's no reason that medical devices and diagnostic products, the stuff that these professionals use on a daily basis, wouldn't grow, too. By putting your savings into Abbott Labs and Johnson & Johnson, you can expect to outperform most bonds while enjoying the safety of two of the safest health-care investments on the market.

Fool contributor Brian Wilson doesn't own any shares of any company mentioned. You can email him at brian.wilson@hyperioncapitalresearch.com. The Motley Fool owns shares of Abbott Laboratories and Johnson & Johnson. Motley Fool newsletter services have recommended buying shares of Pfizer, Abbott Laboratories, and Johnson & Johnson. Motley Fool newsletter services have recommended creating a diagonal call position in Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On November 08, 2011, at 7:02 PM, DividendsBoom wrote:

    Financial engineering in search of a higher pe, nothing more, nothing less. Nobody has explained how ACTUAL value is being created.

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