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Health-care stocks have suffered from a reform-induced hangover for more than a year now. The sector has lagged the market all through the hotly debated reform negotiations, and even after the bill's passage in March. But the headline risk surrounding health-care stocks has created intriguing buying opportunities for long-term investors. Uncertainty has kept a cap on stock valuations, but investors should focus instead on long-term demand.
Rising health-care costs are nearing 18% of GDP; that's why we started the reform debate in the first place. During a period described by longtime money manager Jeremy Grantham as "seven lean years," health care's the one area of the economy we know will stay fat and happy, thanks to the expansion of insurance to an estimated 32 million Americans, and the growing demand from aging baby boomers.
The following three health-care stocks are currently suffering from a hangover. But as the pressure slowly subsides, I think these companies will reward long-term investors.
The drugmaking dynamo
Novartis AG (NYSE: NVS ) is one of the most diversified health-care companies in the world, with leading positions in brand-name and generic drugs -- its Sandoz division trails only Israel's generic-drug giant Teva Pharmaceuticals (Nasdaq: TEVA ) -- vaccines and diagnostics, and consumer products.
Thanks to Sandoz, Novartis will benefit from the steep patent cliff that most pharmaceutical companies face in the coming years. But in the "turnabout is fair play" department, Novartis' brand-name drug business faces its own headwinds, since its lead drug, Diovan, will face generic competition in 2012. Still, a rock-solid pipeline should mitigate this risk. Novartis boasts about 55 drugs that it plans to file for approval from now through 2014, split among new drugs, new indications, and new formulations.
Companies with market caps greater than $100 billion rarely get me excited. But given Novartis' cheap valuation, and its pipeline rich in late-stage blockbuster potential, this one's piqued my interest. Novartis sells for 13.4 times trailing earnings and 11 times forward earnings-per-share estimates of $4.58. Historically, the stock has traded between about 15 and 25 times earnings, but health-care reform and industrywide patent expirations have created a great deal of uncertainty for drug companies.
The healthy insurer
UnitedHealth Group (NYSE: UNH ) is the largest private health insurer, based on annual premium revenue of roughly $80 billion. The health-insurance industry will likely suffer the most from reform, amid strict regulations and caps on profit margins. Nonetheless, as 32 million more Americans get health care, big three insurers UnitedHealth, WellPoint (NYSE: WLP ) , and Aetna's (NYSE: AET ) role in keeping health-care costs in check will keep them around for some time to come.
UnitedHealth is trading near record lows, using just about any valuation metric imaginable. After beating earnings estimates this week, and once again raising its annual EPS guidance to $3.50, UnitedHealth still trades for less than nine times earnings estimates for the year. At a time when government intervention has spooked most investors -- in some cases rightly so -- I think the market is overestimating the likelihood of a federal takeover of health insurance. Given the government's on- and off-balance-sheet long-term liabilities, and the slim likelihood that a future president would expend his/her political capital on a complete privatization of the insurance industry, I like the odds that UnitedHealth will be here for quite a while.
The balm for investors' woes
Gilead Sciences (Nasdaq: GILD ) dominates the HIV treatment market with blockbuster drugs Truvada and Atripla, which boast roughly $5 billion in combined sales. Despite its dominance in a high-margin, rapidly expanding sector, the stock has fallen nearly 30% since April. The market has discounted its stock far enough to warrant a bit of toe-dipping for value-oriented investors. Gilead currently trades for 12 times trailing earnings and 10 times this year's estimated EPS.
Fear over Gilead's weakening competitive position, declining Medicaid reimbursements, and pricing pressure in Europe has pushed the company from "growth stock" status into "value" territory. Its heavy reliance on a single market makes Gilead a riskier bet than the two stocks above. That said, I think the market has oversold the potential rapid decline of Gilead's highly profitable HIV franchise.
A Foolish diagnosis
Investing in health-care stocks can be unnerving, given the wide range of possible outcomes with pipeline candidates, and the uncertainty surrounding the effects of health-care legislation. With these risks in mind, I believe the price is right for the stocks above. Value investors, feel free to start getting your feet wet.