A Primer on the Health-Care Sector

 

Worldwide Invest Better Day 9/25/2012

This month at The Motley Fool, we're committing ourselves to getting back to basics, culminating on Sept. 25 with Worldwide Invest Better Day. So far, my Foolish colleagues have armed you with information from the worst investment advice we've received to our favorite investing books. In a previous article, we reviewed stock diversification, a key fundamental of investing. Today, we'll focus on health-care stocks.

An overview of the health-care sector
Composed of biopharmaceutical, medical equipment and technology, and health-care service companies, this sector is generally less sensitive to swings in the economy than other, more cyclical sectors such as tech and consumer discretionary. The health-care sector faces many challenges, though, including possible cuts to Medicare. But while the sector faces headwinds, it also offers ample opportunities for investors.

Trends and challenges facing the sector
One major growth driver for the sector is favorable demographics. People are living longer, and an aging population leads to increased spending on health care. As we wear out, coronary stents are implanted, pills are popped, and knees are replaced more frequently. Companies that may benefit include medical-device makers MAKO Surgical (Nasdaq: MAKO  ) and Intuitive Surgical (Nasdaq: ISRG  ) , which enjoy high-margin recurring revenues as a result of their business models. While both companies offer robotic systems to hospitals, primarily for minimally invasive surgeries, MAKO has lost ground to Intuitive Surgical, which is expanding into new procedures such as hysterectomies.

Then there's pharma. Big pharmaceutical companies such as Pfizer and Novartis continually feel pressure from highly competitive generic-drug makers such as Teva Pharmaceuticals (Nasdaq: TEVA  ) . Since branded drugs have an expiration date on their patent protection, Teva waits in the wings ready to swoop down and add them to its seemingly endless drug pipeline. Teva shareholders also love that the company has more than doubled its dividend over the past five years. And with a payout ratio of only 21%, Teva possesses lots more room to grow that dividend.

Be aware that less-than-perfect drug-approval process outcomes can send health-care stock prices tumbling. Biotechs VIVUS (Nasdaq: VVUS  ) and Arena Pharmaceuticals (Nasdaq: ARNA  ) have both gained approval for their respective obesity drugs, Qsymia and Belviq, in the U.S., where 35% of adults are considered obese. But on Friday, VIVUS released a statement indicating that Qsymia will probably face rejection from the EU and saw its share price plummet 12%. Despite VIVUS's stock performance on Friday, Arena and VIVUS stocks have enjoyed tremendous gains of 374% and 110%, respectively, since the first of the year. But make no mistake: Biotech stocks aren't for the faint of heart.

Watch for other health-care trends, including:

  • Growth in emerging markets. As developing countries have become wealthier, diets are improving, and increased wealth may lead to increased health.
  • Continued medical innovation that will include more technologies to address diseases.
  • A trend still in its infancy -- personalized medicine, which takes into account an individual's genetic makeup.
  • Potential cuts to the U.S. federal budget that currently target health care. Different players in the health-care system would feel Medicare cuts differently -- hospitals and managed-care facilities are probably more at risk than generic-drug makers are.

Get sector exposure the simple way
Roughly 14% of your overall stock portfolio should be allocated to health care, using the MSCI World Sector Weightings as a benchmark. But what if you don't have the time or desire to examine health-care stocks? Sector-specific exchange-traded funds, such as theHealth Care Select Sector SPDR ETF, are helpful when you're dabbling in a sector that's not your specialty.

Prescription for a vigorous portfolio
Making a bet the wrong way in the stock market could cost you. Instead, develop a diversified strategy for adding all sectors to your portfolio. That way you'll know, regardless of what happens in the market, that a portion of your portfolio will prevail.

Want to stay up to date on Arena Pharmaceuticals? Check out our brand-new premium research report.  In the report, you'll find everything you need to know, including key opportunities and risks facing the company. You'll even score a year's worth of updates from our analysts. Check out the details here.

Join us for more investing basics on our microsite for Worldwide Invest Better Day. On the site, we've posted tons of great articles aimed at helping you do just that.

Fool contributor Nicole Seghetti owns no shares in any of the companies mentioned in this article. Nicole welcomes you to follow her on Twitter, @NicoleSeghetti. The Motley Fool owns shares of Intuitive Surgical and MAKO Surgical. Motley Fool newsletter services have recommended buying shares of Intuitive Surgical and MAKO Surgical. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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