Good buys in healthcare and drug stocks

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Steven T. Goldberg

Healthcare stocks are cheap. Enactment of healthcare reform last year has Wall Street fretting that industry profits will be depressed. But those fears are unwarranted.

With the aging of the population not only in the U.S. but throughout the developed world, as well as advances in medical technology, people will continue to spend more on healthcare, not less.

 Paul Larson, editor of Morningstar StockInvestor newsletter (telephone 1-866-910-1145), which has a terrific track record, is finding more attractively priced stocks today in healthcare than in any other sector.

“That’s a reflection of market fears about healthcare reform,” Larson argued, and I agree. Health reform is a net plus for healthcare companies, most of which backed the legislation.

Yes, almost all healthcare companies — medical device makers, pharmaceutical firms, hospitals and health insurance companies — will see their prices squeezed. But the new law will provide health coverage to tens of millions of people who are currently without insurance, increasing the number of customers.

“Total healthcare spending will increase under Obama’s plan,” Larson said.

 Health reform isn’t the only thing that has turned Wall Street against health stocks. Numerous blockbuster drugs have either lost patent protection or are on the verge of losing it, leading to pressure on pharmaceutical stocks.

But Larson and I both think investors have more than priced these losses into current stock prices. And a slew of new medications are on the way.

Attractive healthcare stocks

 So if this is a good time buy healthcare and drug company stocks, where to invest? Here are some stocks and mutual funds worth considering.

Pfizer (PFE), the world’s largest pharmaceutical firm, faces patent expirations of several blockbusters: anti-depressant Effexor, cholesterol drug Lipitor, and impotence drug Viagra. But the patent expirations are more than reflected in Pfizer’s dirt-cheap price.

Pfizer trades at just 7 times consensus analyst estimates for 2011 earnings. Yet it has 100 new drugs in its pipeline, including about 30 in late-stage clinical trials.

Johnson & Johnson (JNJ) is the world’s largest and most diverse health company. It develops and sells pharmaceuticals, consumer products and medical devices. Product safety issues have rocked the company of late. But, again, Wall Street has overreacted. The stock trades at 12 times projected 2011 earnings.

Medtronic (MDT) makes medical devices, such as pacemakers, stents and insulin pumps. It has been a strong innovator, particularly in treatments for cardiovascular diseases, and is working on new therapies for atrial fibrillation. Medtronic trades at just 10 times analysts’ 2011 estimated earnings.

Finding a fund

Prefer to hire a pro to pick your health stocks? Vanguard Healthcare (1-800-635-1511) and T. Rowe Price Health Sciences (1-800-638-5660) are both excellent funds with annual expenses of just 0.36 percent and 0.87 percent, respectively.

The Vanguard fund is less risky. It’s about 20 percent less volatile than Standard & Poor’s 500-stock index, and it lost only 18 percent in 2008 compared to 37 percent for the S&P 500. The T. Rowe Price fund is just a shade less volatile than the S&P; it tumbled 29 percent in 2008.

 Still, the T. Rowe Price fund has performed a little better than the Vanguard fund. Over the past 10 years, it has returned an annualized 5.5 percent compared to 5.1 percent for the Vanguard fund.

Ed Owens has run Vanguard Healthcare since inception in 1984. Kris Jenner has been at the helm at T. Rowe Price Health Sciences since 2000.

Owens tends to favor pharmaceutical companies and to underweight biotechnology. Jenner likes smaller companies, including biotech. One negative to Vanguard Health: It requires a $25,000 minimum initial investment.

 Speaking of biotechnology, I think the best way to invest in that tricky sector is through an exchange-traded fund (ETF) — in other words, a fund that trades like a stock. SPDR Standard & Poor’s Biotech Index (symbol XBI) invests in the largest 29 biotech companies.

Unlike most index ETFs, it puts an equal amount of money into each of its holdings. Thus, you get the handful of well-established biotech companies, such as Amgen, as well as lots of more speculative fare.

Many of those smaller firms will surely fail — they often have just one or two drugs in development. But the odds are strong that some will hit the jackpot. Note: Don’t overdo this risky ETF.

Steven T. Goldberg is a freelance writer and investment advisor in Silver Spring, Md. He welcomes reader ques­tions. E-mail steve@tginvesting.com or write to Steven Goldberg, 9005 Woodland Dr., Silver Spring, MD 20910. You may also call him at (301) 650-6567.