Health Care Sector 4Q16: Best and Worst

Sector Analysis 4Q16

The Health Care sector ranks seventh out of the ten sectors as detailed in our 4Q16 Sector Ratings for ETFs and Mutual Funds report. Last quarter, the Health Care sector ranked sixth. It gets our Dangerous rating, which is based on an aggregation of ratings of 23 ETFs and 85 mutual funds in the Health Care sector as of October 11, 2016. See a recap of our 3Q16 Sector Ratings here.

Figures 1 and 2 show the five best and worst rated ETFs and mutual funds in the sector. Not all Health Care sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 23 to 352). This variation creates drastically different investment implications and, therefore, ratings.

Investors seeking exposure to the Health Care sector should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2.

Figure 1: ETFs with the Best & Worst Ratings – Top 5

NewConstructs_ETF_HealthcareSectorRatings_4Q16

* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5

NewConstructs_MF_HealthcareSectorRatings_4Q16

* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Live Oak Health Sciences Fund (LOGSX) and Saratoga Health & Biotechnology Portfolio (SBHIX) are excluded from Figure 2 because their total net assets (TNA) are below $100 million and do not meet our liquidity minimums.

iShares Global Healthcare ETF (IXJ) is the top-rated Health Care ETF and Putnam Global Health Care Fund (PHSYX) is the top-rated Health Care mutual fund. Both earn an Attractive rating.

BioShares Biotechnology Products Fund (BBP) is the worst rated Health Care ETF and AllianzGI Health Sciences Fund (RAGHX) is the worst rated Health Care mutual fund. Both earn a Very Dangerous rating.

340 stocks of the 3000+ we cover are classified as Health Care stocks, but due to style drift, Health Care ETFs and mutual funds hold 352 stocks.

AmerisourceBergen Corp (ABC: $79/share) is one of our favorite stocks held by Health Care ETFs and mutual funds and earns a Very Attractive rating. Over the past decade, ABC has grown after-tax profit (NOPAT) by 13% compounded annually. The company has improved its return on invested capital (ROIC) from 6% in 2005 to a top-quintile 16% over the last twelve months. Despite the improving fundamentals, ABC remains undervalued. At its current price of $79/share, ABC has a price-to-economic book value (PEBV) ratio of 0.9. This ratio means the market expects ABC’s NOPAT to permanently decline by 10% from current levels. If ABC can grow NOPAT by just 6% compounded annually for the next decade, the stock is worth $101/share today – a 28% upside.

Amedisys (AMED: $47/share) is one of our least favorite stocks held by Health Care ETFs and mutual funds and earns a Very Dangerous rating. AMED is on October’s Most Dangerous Stocks list as well. Over the past five years, Amedisys’ NOPAT has declined by 16% compounded annually. The company’s ROIC has fallen from 12% in 2010 to a bottom-quintile 4% TTM. Despite the deteriorating business fundamentals, AMED remains priced for significant profit growth. To justify its current price of $47/share, AMED must grow NOPAT by 10% compounded annually for the next 11 years. This expectation seems rather optimistic given AMED’s declining profit over the past five years. This scenario also assumes AMED is able to grow revenue and NOPAT without spending on working capital or fixed assets, which is unlikely but allows us to create a very optimistic scenario. For reference, AMED’s invested capital has grown on average $88 million (7% of 2015 revenue) per year over the past decade.

Figures 3 and 4 show the rating landscape of all Health Care ETFs and mutual funds.

Figure 3: Separating the Best ETFs From the Worst ETFs

NewConstructs_ETF_HealthcareSectorRatingsLandscape_4Q16

Sources: New Constructs, LLC and company filings

Figure 4: Separating the Best Mutual Funds From the Worst Mutual Funds

NewConstructs_MF_HealthcareSectorRatingsLandscape_4Q16

Sources: New Constructs, LLC and company filings

This article originally published here on October 11, 2016.

Disclosure: David Trainer and Kyle Martone receive no compensation to write about any specific stock, sector or theme.

Click here to download a PDF of this report.

Photo Credit: Sergei Golyshev (Flickr)

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