This New Google-Backed Healthcare IPO Could Be Hotter Than Snowflake
Amwell made its debut on the markets on Sept. 17.
Everybody needs healthcare. Or at least they will need it at some point in their lives. And when there’s something that everyone needs, there’s a huge opportunity for investors.
Over $7.8 trillion is spent on healthcare globally. Nearly half of that total -- $3.5 trillion -- is spent in the U.S. With the healthcare sector growing significantly faster than the overall global economy, these numbers will almost certainly be much bigger by the end of the decade.
How can investors profit from this growth? Here’s what you need to know about investing in healthcare stocks.
The healthcare sector is so broad that there are several different kinds of healthcare stocks. Four of the most important types of healthcare stocks are:
Strong companies can be found within each of type of healthcare stocks, and we're breaking down an example of each below with more on Vertex Pharmaceuticals (NASDAQ:VRTX), Intuitive Surgical (NASDAQ:ISRG), UnitedHealth Group (NYSE:UNH), and Teladoc Health (NYSE:TDOC).
How can you find the best healthcare stocks to buy? There are four key things to look for.
The most important thing you’ll want to check out with any healthcare stock you’re considering is the company’s growth prospects. See how quickly the company’s revenue has grown in recent years. The future doesn’t always mirror the past, but if a company hasn’t been able to deliver strong revenue growth, it probably won’t be able to do so going forward.
Read companies’ investor presentations on their websites to learn what their strategy is for growth and how big they think their potential market is. Check out the companies’ rivals to see if their strategies seem to be just as good or even better. By the way, companies will often mention specific competitors by name in their 10-K annual regulatory filings to the U.S. Securities and Exchange Commission (SEC).
Those regulatory filings to the SEC also include financial statements that can help you evaluate the financial strength of a given company. Ideally, a company will already be profitable. If it isn’t, make sure you learn how the company plans to achieve profitability and how quickly it expects to do so.
A company’s cash position, which includes cash, cash equivalents, and short-term investments, can be found on the balance sheet (a financial statement that lists all of the company’s assets, liabilities, and shareholder equity) in its annual and quarterly regulatory filings. Think about this in the same way you’d think about the amount of money in your checking, savings, and retirement accounts: the more, the better.
Another important gauge of financial strength is the free cash flow (FCF) that a company generates. FCF measures the cash left over after paying for operating expenses and capital expenditures (money spent on things like buildings, equipment, and land). As is the case with the cash position, the higher a company’s FCF is, the stronger its financial position is.
You’d want to know how much a new car is worth before buying it. Determining the valuation of a healthcare stock before buying is also important so you can make sure you’re paying a fair price for it.
There are quite a few valuation metrics that can be used. The most popular one is the price-to-earnings (P/E) ratio, which measures the price of a stock in relation to its earnings per share -- what you get in earnings for every dollar you invest.
Some P/E ratios are backward-looking, reflecting earnings over a prior period of time (typically the last 12 months). Forward P/E ratios, which use earnings estimates for one year into the future, can be more helpful in assessing the valuation of fast-growing healthcare stocks. Comparing P/E ratios with other stocks in the same industry will help you determine if the stock is relatively cheap or relatively expensive.
Just because a stock’s P/E ratio is higher than its peers doesn’t mean that it’s not a good one to buy, though. It could indicate the company’s growth prospects are much better than those of its rivals. Be sure to also check out the stock’s price-to-earnings-to-growth (PEG) ratio, which incorporates projected earnings growth rates (typically over a five-year period). Stocks with lower PEG ratios (especially when the ratios are less than one) are more attractively valued than those with higher PEG ratios.
Some healthcare stocks pay dividends -- a portion of earnings that the company returns to shareholders. Dividends can boost the overall return that you receive from owning a stock.
The dividend yield tells you how much a stock’s annual dividend payments are as a percentage of the current share price. Consider the stock’s payout ratio, which measures dividends as a percentage of earnings and indicates how much of the company’s cash is being used to cover the dividend. The lower the payout ratio is, the greater the likelihood is that the company will be able to keep paying dividends in the future.
Your dollars and mine, our capital, is helping shape the world.David Gardner, cofounder, The Motley Fool
Investing in any kind of stock comes with risks, including the possibility that competitors will develop products and services that are more successful in the marketplace. Healthcare stocks face these risks as well as other risks more specific to the healthcare sector.
Healthcare is highly regulated. Drugmakers and medical device makers could fail to secure the necessary regulatory approvals to market their new products. Regulatory changes could drastically alter a healthcare stock’s growth prospects. In the U.S., the Food and Drug Administration (FDA) oversees regulating drugs and medical devices. It’s smart to pay attention to any FDA events related to stocks that you’re watching.
Many healthcare stocks also face significant litigation risk. For example, biopharmaceutical companies, medical device makers, and healthcare providers can be sued if patients think that the companies’ products and services have caused them harm.
In addition, drugmakers and medical device makers must convince payers, including health insurers, PBMs, and government agencies, to pay for their products. If companies aren’t successful in obtaining reimbursement approvals, it could reduce their growth prospects.
Despite these risks, the overall outlook for healthcare stocks appears to be very good over the long term. Aging demographic trends across the world combined with advances in technology should open up tremendous opportunities for healthcare stocks -- and provide healthy returns for patient investors.
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