We like healthcare stocks. Healthcare spending is rising at about 8% per year. We expect National Health Expenditures (NHE) as a share of GDP to be 19.6% by 2019. Growing healthcare costs are not good for patients or taxpayers, but it benefits those who invest in healthcare stocks. Additionally, the financial markets have been extremely unstable in the past few years. We think investors should play more defensively in the near term in order to protect themselves from another crisis.
We define defensive stocks as stocks with low beta and low debt. We also prefer stocks with decent dividend yields and attractive multiples. The best thing about these stocks is that they pay us to wait for the appreciation in their stock prices. In this article, we are going to discuss a few stocks related to the healthcare industry that can provide a margin of safety to defensive investors.
Ticker | Company | Forward P/E | Dividend Yield | Debt/Equity | Beta |
Eli Lilly & Co. | 10.82 | 4.96% | 0.47 | 0.7 | |
Merck & Co. Inc. | 10.3 | 4.35% | 0.33 | 0.66 | |
Pfizer Inc. | 9 | 4.18% | 0.46 | 0.72 | |
Walgreen Co. | 11.15 | 2.69% | 0.16 | 0.96 |
Eli Lilly is one of the defensive stocks. It has a beta of 0.7 and a total debt-to-equity ratio of 0.47. However, analysts are pessimistic about LLY. The average analyst recommendation score for LLY is 3.10 (1=strong buy, 2=buy, 3=hold, 4=sell, 5=strong sell). The company is facing challenges in protecting its branded patents and developing new drugs. Recently LLY's patent on Zyprexa expired. Eli Lilly has other patents that will expire soon. Though LLY has some plans to counter these patent expirations, there is still the possibility that it fails to develop or commercialize new drugs. As a result, LLY is trading at attractive multiples compared with its major competitors. Its current P/E ratio is 10.13, versus 16.55 for Pfizer Inc and 18.87 for Merck. It also has a high dividend yield of 4.96%. At the end of the third quarter, there were 25 hedge funds with LLY positions. Billionaire Jim Simons is the most bullish hedge fund manager about LLY. Simons' Renaissance Technologies had $262 million invested in LLY at the end of September.
We actually like PFE and MRK as well. Though their current P/E ratios are both higher than that of LLY, their forward P/E ratios are lower. PFE has a forward P/E ratio of only 9, and MRK's forward P/E ratio is slightly over 10. The debt-to-equity ratios of PFE and LLY are almost the same. So are their betas. MRK's beta and debt-to-equity ratio are both lower than those of LLY. PFE has a total debt-to-equity ratio of 0.46 and a beta of 0.72, and LLY has a debt-to-equity ratio of 0.33 and a beta of 0.66. MRK is as popular as LLY among hedge funds. There were also 25 hedge funds with MRK positions in their 13F portfolios. PFE is much more popular. As of September 30, 2011, there were 74 hedge funds disclosed to own PFE in their 13F portfolios. For instance, Ken Fisher's Fisher Asset Management had nearly $400 million invested in PFE at the end of the third quarter.
Walgreen Co is also an attractive defensive stock to invest in. Though it is not classified in the "healthcare" sector, it operates drug stores. WAG has a beta of 0.97 and a total debt-to-equity ratio of 0.16. It also has a lower P/E ratio compared to its main competitors and the industry. Its current P/E ratio is 11.34, versus 17.02 for CVS Caremark Corporation (CVS), 13.11 for Wal-Mart Stores Inc (WMT), and 20.73 for the average of drug stores industry. Its forward P/E ratio is also lower than those of its peers. WAG has a forward P/E ratio of 11.15, compared with 13.21 for CVS and 12.62 for WMT. WAG is also quite popular among hedge funds. At the end of the third quarter, there were 36 hedge funds disclosed owning WAG in their 13F portfolios. For example, Jim Simons' Renaissance Technologies initiated a brand new $45 million position in WAG over the third quarter. Cliff Asness' AQR Capital Management also had $44 million invested in this stock at the end of September. On the other hand, WAG is also faced with certain challenges. The company is currently negotiating a contract renewal with Express Scripts (ESRX), a pharmacy benefit operator. The longer it takes WAG to reach an agreement with ESRX, the greater the negative impact will be on WAG. The company is also exposed to the risks of increasing competition from its peers as well as the changes in the drug reimbursements regulations.
A few other stocks outside of the healthcare sector for defensive investors who seek a margin of safety are Travelers Companies Inc (TRV), Staples Inc (SPLS), Newmont Mining Corp (NEM), Thomson Reuters Corporation (TRI), Exxon Mobile Corporation (XOM) and 3M Co (MMM). Investors looking for sector diversification may also consider adding these positions to their portfolios. Defensive stocks are less risky than the market and are more stable compared with other stocks, especially during market turmoil. We urge investors to do some in-depth research on these defensive stocks and consider adding some of them to their own portfolios.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
