Health-Care Reform for Dummies

Health-care reform. Seldom has an idea so mundane given rise so much controversy. In recent months we've debated whether America has the world's best health-care system ... or one of the worst. Whether universal coverage or the free market is the right answer.

And of course, the biggest question: Whom do we tax to pay for it?

Yes, raise taxes -- on that guy over there
In a recent AP-Stanford University poll, Americans came out resoundingly in favor of raising taxes ... on somebody else. Asked whether Congress should tax "Cadillac" insurance plans, voters worried that their plans might be considered "Made in Detroit" -- and voted "no" (just to be safe).

But voters like the idea of raising taxes on people earning $250,000 and up (voting nearly two-to-one in favor of such a tax). And they positively adore the idea of taxing "the rich" -- hitting up $500,000-annual earners with a 5.4% income tax surcharge. As one Mary Pat Rondthaler, of Menlo Park, Calif., exclaimed: "You know, I mean, why not? If they have that much money, it should be taxed. It isn't the same way that the guy making $21,000 is."

"We're" normal, "they're" rich
In much the same way as everyone driving faster than you on the highway is "a maniac," it seems anyone making more money than we are must be "rich" ... and should be taxed accordingly. (Never mind the counterargument that if you raise their taxes, the rich will work less, make less profit, and have less money to hire workers at "normal" wages.)

Yet here's the curious thing. Individuals polled in the survey voted down the idea of raising taxes on insurance companies, drugmakers, and medical device manufacturers. Yet these same voters averred that they believe such companies also "made too much." 72% said insurance companies are too profitable. 74% agreed drug and device manufacturers get too much loot.

Engage brain, then speak
It gets a Fool to wondering. If "the rich" should be taxed because "they have that much money," then shouldn't the same logic hold true for companies? Is there a logical disconnect in our national thinking?

Maybe not. Let's take a look at a few potential targets of health-care reform-oriented taxation. First up, the-health insurance companies:

*In billions.

More than $7 billion in profits earned by just three of the nation's many insurers. Seems like a lot, but when compared to the pharmaceutical industry, maybe it isn't ...

*In billions.

So here we have two industries, Big Pharma and Big … um, Insura. The latter averages 4% profit on its revenues. The former makes closer to a 24% margin. Yet according to voters, they're both too rich. Hmmm. I'm beginning to see why the pollsters' data seemed to run in circles and bite itself on the tail.

Just for fun, now, let's compare these two industries to a few companies drawn from across the rest of the economy:

*In -- yep, you guessed it -- billions.

And now we see why the logic of raising taxes on these companies falls apart. Oracle and Apple earn profit margins right in line with the pharmaceutical companies. Their combined revenues, profit margins, and net profits fall roughly in line with those of Johnson & Johnson -- yet somehow, "Big Tech" gets a pass on the "makes too much money" argument.

Seems when you get right down to it, whether a company is "too rich" depends on the preconceptions we bring to the table -- a lot like our tax policy.

The Foolish investing takeaway
Like the pollsters at AP, investors can fall into the same trap. Just because a company makes a lot of money doesn't mean it's the best place for your money. At Motley Fool Hidden Gems, we don't want to own the most profitable (read "biggest") companies -- they're often the ones with the highest price tags and the smallest growth prospects. We want to own the most profitable (read "best") companies.

And you should, too. For example, we recently recommended that our members buy shares of IMS Health. IMS isn't the biggest company in health care -- its $2.2 billion in annual revenues hardly earn it a seat at the table. At first glance, it doesn't look like the most profitable either, with a 13% profit margin putting it somewhere between the insurers and the drug companies in terms of profits earned per revenue dollar.

But if you look beyond the obvious, IMS is arguably superior to many of the bigger companies named above, generating cash profits in excess of $490 million the last 12 months -- a 22.6% free cash flow margin. That was good enough for us ... and within weeks of our recommending it, the stock proved good enough for private equity as well -- getting bought out at a 44% premium to our initial purchase price.

So I guess we know at least one group that's unarguably "rich" -- IMS shareholders.

Where will the Hidden Gems team strike gold next? Take a free, 30-day trial to the service and find out.

Fool contributor Rich Smith does not own shares of any company named above, but The Motley Fool owns shares of UnitedHealth. Apple and UnitedHealth Group are Motley Fool Stock Advisor recommendations. Pfizer, Unitedhealth Group, and WellPoint are Motley Fool Inside Value selections. Johnson & Johnson is a Motley Fool Income Investor recommendation. The Motley Fool owns shares of and wrote puts on Oracle. The Fool's disclosure policy is alive and kickin'.