As more uncertainty hits the stock market, defensive sectors like healthcare are starting to look attractive once again. Healthcare stocks are a wide universe, with over 1,100 listed on major U.S. exchanges.
Many healthcare investors focus on faster-growing companies, or those in faster-growing segments of the sector, but it's a great place to find undervalued gems as well. Although plenty of stocks in this category are cheap for a reason, and are at risk of becoming value traps, there are a few where the market has overreacted, creating an ideal situation for contrarian investors.
That's the situation with the following three undervalued healthcare stocks.
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1. DaVita is not the value trap it appears to be at first glance
So far this year, shares in dialysis center operator DaVita (DVA 0.31%) have slumped, falling by around 14% since January. A variety of factors have put pressure on the stock.
These have included disappointing quarterly earnings releases, a ransomware attack, and reports on Warren Buffett's Berkshire Hathaway, a longtime DaVita shareholder, trimming its position.
However, while all of this gives DaVita some serious value-trap vibes, there are silver linings to these perceived negatives. Berkshire's steady selling has to do with a shareholder agreement in which it sells shares back to DaVita when its ownership percentage exceeds 45%. This happens often because DaVita continues to aggressively repurchase shares.
NYSE: DVA
Key Data Points
Regarding earnings, DaVita is expanding internationally. This growth, coupled with the stability of its U.S.-based core business, could mean more well-received quarterly earnings releases in the future. The stock, trading at a forward price-to-earnings ratio (P/E) of 11, could experience valuation expansion as well.
2. Merck could surge once its patent expiration issue is resolved
Merck (MRK +0.05%) has yet to release a blockbuster drug for weight loss, but the pharmaceutical giant continues to report strong earnings, namely from its cancer drug Keytruda. The issue, however, is that the drug's patent protection expires in 2028.
When that happens, the release of generic biosimilars will likely lead to a severe reduction in Keytruda sales. So it's not surprising you can buy this stock today for just 9 times forward earnings. However, Merck could find a solution to this big problem.
NYSE: MRK
Key Data Points
The launch of Keytruda Qlex, a subcutaneously administered version, may mitigate the impact. Merck also has 20 potential blockbuster drugs in its pipeline, representing $50 billion in potential revenue. If these efforts calm worries about Keytruda, the stock could experience a moderate re-rating to a forward valuation in the low to mid-teens, on par with other pharma stocks.
3. Earnings growth could boost Universal Health Services
Universal Health Services (UHS 0.11%) owns facilities for acute care and behavioral healthcare services. Although it's on the smaller end of large-cap stocks -- valued at $13 billion -- not to mention steadily profitable, shares trade at a discount to similar names.
NYSE: UHS
Key Data Points
The stock trades for only 9 times forward earnings estimates, while hospital operators like Tenet Healthcare and HCA Healthcare trade for 13 and 15 times forward earnings, respectively.
Still, assuming Universal Health Services' earnings keep growing in line with sell-side analysts' forecasts, not only could the stock rise in tandem with earnings growth, but there may also be room for shares to experience a moderate re-rating as well.
