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Summary

  • Healthcare sector is expensive on a PEG basis.
  • Healthcare sector trades at a premium PE to the market versus a historical discount to market.
  • Recommend under-weighting healthcare in long portfolios and a long energy short healthcare in more aggressive portfolios.

In our previous article we recommended investors overweight the energy sector based on both intermediate and long term growth rates relative to current valuation. Our recommendation is a relative recommendation meaning we expect sectors to outperform or underperform the market, regardless of overall direction.

We continue our sector analysis and recommend investors underweight healthcare stocks.

First lets look at the healthcare sector from and earnings growth and valuation perspective. Healthcare has a projected P/E of 17.44 based on FY2014 estimates. Healthcare earnings are projected to grow by 19.7% in 2014 and by 11.84% over the next five years. This gives the healthcare sector a PEG ration of 1.47 at the higher end of the S&P sector spectrum but trailing slower growing sectors.

From a historical perspective we look at the five year average P/E ratios and the sectors relative premium or discount to the market multiple. Currently the healthcare sector has a P/E of 19.81 relative to a five year average of 14. 4.

Currently, the healthcare sector boasts a P/E ration at a 15% premium to the market P/E. Given the projected earnings growth this figure is slightly more modest on a forward basis with healthcare at a 11.8% premium to the market.

On a historical basis healthcare has traded at a discount to the market multiple. Over the last five years the discount was 11.7% to the market P/E.

Relative Value Conclusions

  • Healthcare is expensive on a PEG basis relative to the market PEG ratio and offers only a modestly higher projected growth rate over five years.
  • Healthcare trades at a premium to the overall market in both current and projected earnings multiples.
  • Historically healthcare has traded at a discount to the market multiple.

INDEX NAME

Forward P/E

5 Year Oper Earnings Growth

PEG RATIO

2013 Earnings Growth

2014 Earnings Growth

S&P500

15.60

11.94

1.31

10.83%

11.86%

Consumer Discretionary

17.84

16.78

1.06

12.80%

14.57%

Consumer Staples

17.40

9.35

1.86

6.02%

6.05%

Energy

13.52

12.44

1.09

-4.40%

14.00%

Financials

13.93

10.36

1.34

28.16%

2.61%

Health Care

17.44

11.84

1.47

2.85%

19.70%

Industrials

16.27

11.26

1.44

11.67%

11.33%

Information Technology

15.10

13.78

1.10

2.72%

17.60%

Materials

16.46

11.19

1.47

-4.29%

29.06%

Telecommunication Services

13.39

6.91

1.94

264.20%

-6.34%

Utilities

15.57

4.28

3.64

1.50%

11.36%

INDEX NAME

5 Year Average P/E

Current P/E

P/E Premium Discount to Market P/E

Projected P/E Premium Discount

5 Year Average P/E Discount/Premium

S&P 500

16.31

17.22

0%

0.0%

0.0%

Consumer Discretionary

20.43

21.10

23%

14.4%

25.3%

Consumer Staples

15.84

18.48

7%

11.5%

-2.9%

Energy

14.20

15.39

-11%

-13.3%

-13.0%

Financials

14.80

13.99

-19%

-10.7%

-9.2%

Health Care

14.40

19.81

15%

11.8%

-11.7%

Industrials

15.02

18.19

6%

4.3%

-7.9%

Information Technology

15.95

17.44

1%

-3.2%

-2.2%

Materials

18.87

20.78

21%

5.5%

15.7%

Telecommunication Services

20.31

12.63

-27%

-14.2%

24.5%

Utilities

14.03

15.91

-8%

-0.2%

-14.0%

Trade Recommendations

  • Long index investors should overweight the energy sector and underweight healthcare. In term of sales energy makes up approximately a 14.5% of the S&P500 allocation whereas healthcare is 12.39%. We recommend increasing the energy allocation to 20% and increase of 5.5% and reducing the healthcare sector exposure by an equal amount.
  • Long/Short investors can take advantage in a market neutral position -- buying the SPDR Energy (NYSEARCA:XLE) and shorting the SPDR Healthcare (NYSEARCA:XLV)
  • Long/Short Investors can take advantage in a market neutral position -- buying specific positions within each sector.

    Large capitalization energy names such as Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and others offer compelling valuations. These names can be offset with short positions in healthcare from high flyers such as Celgene (NASDAQ:CELG) to larger names such as United Health (NYSE:UNH), Wellpoint (NYSE:WLP), or pharmaceutical names such as Pfizer (NYSE:PFE) and Merk (NYSE:MRK)

INDEX NAME

XLE

XLV

Management Fee

0.18%

0.18%

Dividend Yield

1.77%

1.44%

200 Day Volatility

12.68%

13.43%

1 Year Return

16.87%

25.76%

Sources:

  • ETF Database
  • Standard and Poors
Source: Underweight Healthcare In Your Portfolio: A Sector Relative Value Strategy