2023-10-17 15:23:07 ET
Summary
- Healthcare providers are undervalued by about 9% relative to 11-year averages.
- Healthcare equipment is the most overvalued subsector.
- Fast facts on iShares U.S. Healthcare Providers ETF, a healthcare providers fund.
- 10 stocks cheaper than their peers in October 2023.
This monthly article series shows a dashboard with aggregate industry metrics in healthcare. It may also serve as a top-down analysis of a number of healthcare ETFs like Health Care Select Sector SPDR® Fund ETF ( XLV ) and iShares U.S. Healthcare Providers ETF ( IHF ), whose largest holdings are used to calculate these metrics.
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 last week's closing. Columns stand for all the data named and defined above.
VS | QS | EY | SY | FY | ROE | GM | EYh | SYh | FYh | ROEh | GMh | RetM | RetY | |
HC Equipment | -37.23 | -16.01 | 0.0178 | 0.2163 | 0.0135 | 8.68 | 65.02 | 0.0302 | 0.2602 | 0.0292 | 13.15 | 63.77 | -8.06% | -3.27% |
HC Providers | 9.05 | -8.42 | 0.0560 | 1.5705 | 0.0660 | 15.94 | 19.88 | 0.0518 | 1.3926 | 0.0621 | 15.79 | 24.19 | 0.13% | 6.64% |
Pharma/Biotech | -1.90 | 2.56 | 0.0349 | 0.2375 | 0.0314 | 23.82 | 77.78 | 0.0363 | 0.2319 | 0.0328 | 21.90 | 80.75 | -2.25% | 2.72% |
Life Science Tools | -1.87 | 2.44 | 0.0345 | 0.2145 | 0.0286 | 15.98 | 57.85 | 0.0289 | 0.2725 | 0.0297 | 16.12 | 54.71 | -7.28% | -4.68% |
Value and Quality chart
The next chart plots the Value and Quality Scores by subsector (higher is better).
Evolution since last month
Valuation has materially improved in life science tools.
Momentum
The next chart plots median returns by subsector.
Interpretation
Healthcare providers are undervalued by about 9% relative to 11-year averages, but they are slightly below the quality baseline. Pharma/biotechnology and life science tools are close to their historical baselines in both valuation and quality. Healthcare equipment is the less attractive subsector, with value and quality scores significantly below the baseline.
Focus on IHF
iShares U.S. Healthcare Providers ETF has been tracking the Dow Jones U.S. Select Health Care Providers Index since 05/01/2006. It has a total expense ratio of 0.40%, whereas broader sector ETFs like XLV charge only 0.10%.
As of writing, the fund holds 70 stocks and is very concentrated in a few names. The next table shows the top 10 holdings with their weights and some fundamental ratios. Their represent almost 77% of the fund’s asset value. Risks relative to the top three names, and especially to UnitedHealth Group, are high.
Ticker | Name | Weight (%) | EPS growth %TTM | P/E TTM | P/E fwd | Yield (%) |
UnitedHealth Group Inc. | 24.54 | 12.84 | 23.35 | 21.59 | 1.40 | |
Elevance Health, Inc. | 12.88 | 7.07 | 17.32 | 14.05 | 1.28 | |
CVS Health Corp. | 10.19 | -62.98 | 31.37 | 8.32 | 3.39 | |
The Cigna Group | 4.93 | 30.90 | 14.22 | 12.59 | 1.58 | |
Humana Inc. | 4.90 | 9.34 | 19.56 | 18.53 | 0.68 | |
Centene Corp. | 4.89 | 54.40 | 14.65 | 10.97 | 0 | |
Veeva Systems Inc. | 4.15 | 37.18 | 63.76 | 45.32 | 0 | |
HCA Healthcare, Inc. | 3.79 | -2.21 | 11.77 | 12.96 | 1.00 | |
Molina Healthcare, Inc. | 3.55 | 22.65 | 22.55 | 17.09 | 0 | |
Laboratory Corp. of America Holdings | 3.05 | -55.69 | 21.74 | 14.74 | 1.43 |
IHF is very close to XLV in total return since inception, as reported in the next table. The difference in annualized return is just one basis point! However, IHF shows a much higher risk measured in maximum drawdown and historical volatility. Therefore, the risk-adjusted performance (Sharpe ratio) is inferior to the sector benchmark.
Total return | Annualized return | Max Drawdown | Sharpe ratio | Volatility | |
IHF | 478.22% | 10.58% | -58.82% | 0.56 | 18.86% |
XLV | 476.57% | 10.57% | -39.17% | 0.7 | 14.22% |
Data calculated with Portfolio123.
However, IHF has underperformed XLV in the last 5 years:
In summary, IHF is designed for investors seeking capital-weighted exposure to healthcare providers. It may also be used as a component of tactical allocation strategies. The portfolio is overweight in the top constituents. Exposure to UnitedHealth Group, Elevance Health and CVS Health Corp is especially high: their aggregate weight is almost 48%. Moreover, management fees and risk metrics for iShares U.S. Healthcare Providers ETF are significantly higher than for the broad healthcare sector ETF.
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 healthcare provider company with an Earnings Yield above 0.0560 (or price/earnings below 17.86) 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.
Cross Country Healthcare, Inc. | |
HUM | Humana Inc. |
AMN Healthcare Services, Inc. | |
Innoviva, Inc. | |
MOH | Molina Healthcare, Inc. |
DaVita Inc. | |
Cencora, Inc. | |
Tenet Healthcare Corp. | |
Gilead Sciences, Inc. | |
Zynex, Inc. |
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:
IHF: Healthcare Dashboard For October