Some Healthcare Equities Getting Quite Expensive

Includes: BMY, JNJ
by: Bio Insights

Healthcare stocks have for the most part held their ground against the market's declines. This trend has gotten crazy to the point where it seems the market is just ignoring fundamentals and widening the gap between safe havens and risk assets based on their primal instincts and the words of politicians and old banksters who are just as confused as I am. Politics aside, it will be fine for the market if unemployment doesn't improve rapidly in 2012, because the contraction of the consumer market has been drastically overstated during the last few years.

There have been plenty of companies which rely on consumer products that have been able to expand both revenue and earnings throughout the last three years -- and not just defensive ones. The shining example of this is Apple (NASDAQ:AAPL), which had great times even as unemployment remained well above 9%. Dropping risky equities at these low prices for some of the "safest" healthcare stocks, which are challenged by patent cliffs and a recent history of stagnant revenue, is folly.

On average, the best value investments are no longer in healthcare. Even in a recession, while some of these pharmaceutical companies may have immunity to certain market forces, some of these pharma giants were priced to perfection and have relatively little upside given their generally predictable revenue growth over time. While healthcare is a great sector to invest in for the long run, right now many companies in the sector are only attractive for dividend yields and have very little chance of appreciating in share price based on fundamentals for quite some time.

Johnson & Johnson (NYSE:JNJ) is one such company, and probably one of the best examples of an inflated stock relative to the market. I've written on why I think the company is headed sideways for some time to come, but it has a safe dividend which is for the most part the reason I called JNJ a "bond is equity form." JNJ has a pipeline and a strong reputation, but the patent expirations and generic competition will limit the upside for the company.

Revenue has been stagnant since 2008 and the stock has been trading in the 60s since 2005, if you disregard moments of escape from that range. It's now trading just under $65/share and at a high P/E of 15.6. The safety premium is too high, and the stock has little upside. The shares yield 3.5%, and there's nothing wrong with buying shares of JNJ stock exclusively for that. Still, utilities and other healthcare giants are better bets by most metrics. In defense of JNJ buyers, the dividend yield is certainly better than for those who are investing in T-bills.

Bristol-Myers Squibb (NYSE:BMY) is another relatively overpriced healthcare giant given its situation. Revenue growth has been slowly improving and may finally exceed the high made in 2008 this year, and the yield is huge at 4.4%, but whether the stock has big upside potential given how expensive it's become is hard to tell. BMY is going to face issues with patent expirations in the coming years, and at a P/E of 15.5 given the other opportunities in the market, buying shares of BMY for price appreciation makes little sense. Shares of BMY may be available for cheaper than the current price if the market shakes the bearish sentiment, and at that level the yield will be even better. It's likely that you'll make a higher return on a wisely chosen alternative investment, probably outside of healthcare, in the next year or so.

While healthcare stocks are generally overpriced now, it doesn't mean that they are all poor investments. The argument is that other stocks have fallen so much further that by relation, healthcare stocks, especially those that have already reached their pre-August levels, are trading at a huge safety premium and are no longer advantageous buys. Unless you are adamant about starting an investment in healthcare this instant, you may want to pursue other investments which will yield a higher return in the comings months or at least pick the most attractively valued healthcare stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.