NVSEF - IXJ: Healthcare Dashboard For September

2023-09-16 08:26:36 ET

Summary

• The sector as a whole is overvalued by about 15% relative to 11-year averages.
• Healthcare providers and pharmaceuticals/biotechnology look fairly valued, whereas healthcare equipment is the less attractive subsector.
• IXJ: a global alternative to XLV.
• 10 stocks cheaper than their peers in September 2023.

This monthly article series shows a dashboard with aggregate industry metrics in healthcare. It is also a review of healthcare ETFs whose largest holdings have been used to calculate these metrics, like the Health Care Select Sector SPDR ETF ( XLV ) and iShares Global Healthcare ETF ( IXJ ).

Shortcut

The next two paragraphs in italic describe the dashboard methodology. They are necessary for new readers to understand the metrics. If you are used to this series or if you are short of time, you can skip them and go to the charts.

Base Metrics

I calculate the median value of five fundamental ratios for each industry: Earnings Yield ("EY"), Sales Yield ("SY"), Free Cash Flow Yield ("FY"), Return on Equity ("ROE"), Gross Margin ("GM"). The reference universe includes large companies in the U.S. stock market. The five base metrics are calculated on trailing 12 months. For all of them, higher is better. EY, SY and FY are medians of the inverse of Price/Earnings, Price/Sales and Price/Free Cash Flow. They are better for statistical studies than price-to-something ratios, which are unusable or non-available when the "something" is close to zero or negative (for example, companies with negative earnings). I also look at two momentum metrics for each group: the median monthly return (RetM) and the median annual return (RetY).

I prefer medians to averages because a median splits a set in a good half and a bad half. A capital-weighted average is skewed by extreme values and the largest companies. My metrics are designed for stock-picking rather than index investing.

Value and Quality Scores

I calculate historical baselines for all metrics. They are noted respectively EYh, SYh, FYh, ROEh, GMh, and they are calculated as the averages on a look-back period of 11 years. For example, the value of EYh for healthcare providers in the table below is the 11-year average of the median Earnings Yield in this industry .

The Value Score ("VS") is defined as the average difference in % between the three valuation ratios (EY, SY, FY) and their baselines (EYh, SYh, FYh). The same way, the Quality Score ("QS") is the average difference between the two quality ratios (ROE, GM) and their baselines (ROEh, GMh).

The scores are in percentage points. VS may be interpreted as the percentage of undervaluation or overvaluation relative to the baseline (positive is good, negative is bad). This interpretation must be taken with caution: the baseline is an arbitrary reference, not a supposed fair value. The formula assumes that the three valuation metrics are of equal importance.

Current data

The next table shows the metrics and scores as of the last trading day's closing. Columns stand for all the data named and defined above.

Value and Quality chart

The next chart plots the Value and Quality Scores by industry (higher is better).

Evolution since last month

The value score has improved in all subsectors, partly due to price action.

Momentum

The next chart plots median returns by subsector.

Interpretation

According to my S&P 500 monthly dashboard , the sector as a whole is overvalued by about 15% relative to 11-year averages. However, healthcare providers are undervalued by about 10%, and their quality score is slightly below the historical baseline. Pharmaceuticals/biotechnology are very close to their baseline in valuation and quality. Life science tools are overvalued by about 12% regarding the same metrics. Healthcare equipment is the less attractive subsector, showing the lowest value and quality scores.

IXJ: an alternative to XLV

iShares Global Healthcare ETF ( IXJ ) started investing operations on 11/13/2001 and tracks the S&P Global 1200 Health Care Index. It has a portfolio of 114 stocks, an expense ratio of 0.42% and a 12-month distribution yield of 1.27%. The underlying index selects international healthcare companies weighted based on float-adjusted market capitalization. About 70% of asset value is in U.S. companies. The next chart lists the other countries with their weights in the portfolio.

The next table lists the top 10 holdings with fundamental ratios. Their aggregate weight is 43% of asset value. For convenience, tickers of non-US companies are those listed in the U.S., but the fund holds stocks in the primary exchanges.

Ratios: Portfolio123

IXJ is more diversified than XLV, which has 55% of asset value in the top 10 holdings and over 9% in each of the top 2 names (also ((LLY)) and ((UNH)).

In the last 10 years, IXJ has underperformed XLV by 53.6% in total return:

IXJ may be an alternative to XLV for investors seeking an international exposure and a lower concentration in top holdings. Investors seeking a more balanced portfolio may prefer Invesco S&P 500 Equal Weight Health Care ETF ( RSPH ).

Dashboard List

I use the first table to calculate value and quality scores. It may also be used in a stock-picking process to check how companies stand among their peers. For example, the EY column tells us that a large pharma/biotech company with an Earnings Yield above 0.0377 (or price/earnings below 26.53) is in the better half of the industry regarding this metric. A Dashboard List is sent every month to Quantitative Risk & Value subscribers, with the most profitable companies standing in the better half among their peers regarding the three valuation metrics at the same time. The list below was sent to subscribers several weeks ago based on data available at this time.

It is a rotational model with a statistical bias toward excess returns on the long-term, not the result of an analysis of each stock.

For further details see: