5 Stocks To Own As Healthcare Bottoms

by: Victor Dergunov

5 extremely cheap healthcare names with possible 30-50% upside potential.

While defensive sectors like utilities trade at around 18 times forward earnings, many top healthcare names trade below 10.

Rotation, increased demand, earnings/revenue increases, and multiple expansions will likely drive stock prices much higher in this sector.


Image Source

As risk-on returns to markets, we've seen the healthcare sector underperform significantly in recent months. While sectors like technology, communication, discretionary and others surge to new all-time highs, healthcare lags noticeably.

However, many healthcare names have become dramatically oversold in recent months, and even years, in some cases. Meanwhile, high quality companies appear to be incredibly cheap due to the relentless and persistent selling that took place in this sector.

While most segments skyrocketed by 20-30%, or more since the December bottom, healthcare has rebounded by a very modest 6%. This relative underperformance has caused several high quality names to become remarkably cheap.

Chart Data by YCharts

Furthermore, healthcare's defensive nature is a very beneficial element, as market participants are likely to rotate into this segment going forward. This phenomenon will allow for multiples to expand, which should then enable healthcare equities to go substantially higher.

5 Undervalued Healthcare Names

While the average company in the S&P 500 trades at around a 22 P/E multiple, many high-quality healthcare companies are trading at far lower valuations (7-10 times earnings).

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One of the most compelling healthcare names is Bristol-Myers (BMY). BMY's trailing P/E ratio is just 11.3, and its forward P/E is at a remarkably low 10.1.

In addition, the company pays out a solid 3.44% dividend and is expected to provide 6.6% YoY revenue growth, as well as EPS growth rate of 6%.

However, BMY has shown a tenacity to consistently surpass analysts' EPS forecasts. In fact, BMY has crushed earnings in all 4 of its last quarters by an average of 15%. Therefore, it is very plausible, perhaps likely even that BMY can continue to surpass analysts' consensus figures going forward.

This is why I expect the company can earn around $5.11, 15% above consensus estimates. Considering the stock is at $44.80 right not, BMY's forward P/E ratio is at a staggeringly low 8.76.

BMY is at around $45 right now, yet the company's price target estimates are far higher, with just lower-end forecasts at $52, 15% above current prices.

Consensus figures are at $56 for BMY, 25% above current levels, and higher end estimates are around $66, 50% above where the stock trades today.

BMY Consistently Beats Earnings

Source: Nasdaq.com

In BMY, we have a well-positioned, market-leading company, with an incredibly healthy balance sheet, set to grow revenues by 6.6% this year, paying a dividend of 3.44%, and trading at around or under 9 times forward earnings.

It is very likely that BMY and other extremely undervalued healthcare names will begin to outperform the market relatively soon. Also, another very favorable element is that the downside is extremely limited, given the rock-bottom valuations, taking much of the downside risk out of the equation.

Covered Call Dividends Provide Safe High Double-Digit Returns

You can increase yield substantially by implementing a covered call dividend strategy. By writing (selling) June 21st $46 call options, you can pick up a very healthy premium of $1.86 per share. This amounts to a yield of 4.2% for owning BMY for fewer than 2 months. In addition, since the stock is about 2.9% away from BMY's $46 strike price, you're looking at an extremely safe 7.1% gain, 7.7% including regular dividend. You get all this yield in under two months, with remarkably little downside risk.

Moreover, if you continue to implement this covered call dividend strategy with BMY for one year, your return would be around 48%, and this is even presuming the stock remains flat from here.

Essentially, the only way you could stand to begin to lose money on this trade is if BMY crashed by more than 48% over the next year, which seems extremely unlikely.

Technical View

BMY 5-Year Chart

Source: StockCharts.com

Despite BMY reaching a high of around $70 in mid-2016, the stock has rolled back by 36%, all the way back down to $45, about where it was 5 years ago.

While the chart may not appear particularly bullish, I would argue that we are likely near a bottom, as BMY is trading around multi-year support ($44-45). This selloff has been brutal, and BMY now sits at a rock-bottom multiple for no real apparent reason.

BMY is just vastly oversold right now, as the RSI and CCI are, and have been at extremely oversold levels, indicating a very likely shift towards a much more positive tone in technical momentum.

BMY, a Coiled Spring Ready to Surge Much Higher

Most notably, the full stochastic, as it curves up and prepares to break out above the 20 level, is extremely bullish and suggests BMY may be much like a coiled a spring right now.

BMY 1-Year Chart

The one-year chart illustrates what appears to be a clear double or a W-shaped bottom forming in BMY. Given the technical and fundamental/valuation evidence, I expect the stock will rebound and go substantially higher from here.

BMY's Revenues 40% Higher but Stock price the Same

We see that despite BMY's stock price being essentially at the same level it was 5 years ago, the company's revenues increased by about 40%, from around $16 billion to over $25.5 billion over the last 5 years.

BMY's Revenue Growth 5 Years

Moreover, gross profits also increased substantially. Gross profits increased by roughly 37% over the past 5 years.

BMY's Gross Profit Growth 5 Years

EBITDA has exploded by 83% over the last 5 years

Source: Macro Trends

Gilead Photo Source

2. Gilead (GILD) is another remarkable company that is a leader in various areas, including extremely effective AIDS medicines and other efficient leather disease treatments.

Gilead is an essential pillar of the medical community as the company produces drugs for various life-threatening conditions and has numerous drugs about to go through the approval process.

Yet, incredibly, the company's trailing P/E ratio is only a 9.3, its forward P/E is just 8.9, the company distributes a 3.88% dividend, and is expected to deliver revenue growth of 2.6% next year. It seems very likely that a multiple expansion will occur in GILD.

Gilead Appears Very Undervalued

Gilead is extremely undervalued relative to analysts' estimates. 12-month price targets range from $68 to $95, with a consensus estimate at $84.50.

Right now, the stock is trading at $62, implying shares would need to rise by 36% just to achieve consensus estimates, and by more than 50% to get to its higher end estimate figures.

Covered Call Dividend Strategy With GILD

In addition to collecting a very healthy 3.88% annual dividend, investors can also collect a covered call dividend for owning GILD as well. For example, GILD June 21 $65 call options can be sold (written) for around $1.88 today.

This gives you a 3% covered call dividend as well as $2 upside potential in the stock, for an additional 3.2%. So, essentially, you're being paid 6.2% to hold Gilead for about 7 weeks. Annually, this amounts to 46% without the dividend, and almost exactly 50% with GILD's annual dividend payout.

GILD Technical View

We see that GILD made a long-term bottom in mid-2017. Since then, the stock has been in a trading range from about $60 to $86. Right now, the stock is at $62.74, so it is essentially at the very bottom of its multi-year trend.

Also, it appears like GILD made a long-term W-shaped double bottom at the end of last year and is in the process of making a slightly higher high as healthcare names bottom and reverse recent bearish trends.

3. AbbVie (ABBV): trailing P/E ratio: 9.74, forward P/E (based on consensus estimates): 8.16, dividend: 5.3%, revenue growth 5.7%.

You can effectively apply the covered call dividend strategy with ABBV as well, June 21 $80 calls can be sold for around $3, providing a 3.84% dividend for owning this stock for a 2-month period.

ABBV is also quite undervalued relative to analysts' consensus estimates. Higher-end estimates suggest ABBV would need to appreciate by over 75% to achieve its higher $137 price target. This highly discounted enterprise appears to be overlooked and largely ignored by the market.

4. Celgene (CELG): trailing P/E ratio: 10.5, forward P/E (based on consensus estimates): 7.3, dividend: N/A, revenue growth 12.7%.

With such a rock-bottom valuation, it is no wonder estimates are substantially higher for Celgene, with higher-end targets going up to around the $130 level, roughly 40% above Celgene's current price.

5. Biogen (BIIB): trailing P/E ratio: 8.6, forward P/E (based on consensus estimates): 7.5, dividend: N/A, revenue growth 2%.

Biogen delivers a 5% covered call dividend by selling June 21 $235 calls. This is a great, safe return with what appears to be very little downside risk. Biogen is currently around 10% below consensus price estimates, and is far below higher end targets.

Buy Low and Sell High

As many of wise men have said, "when investing, it is always a good idea to buy low and sell high", and it doesn't appear likely that the following healthcare names are likely to go much lower.

To the contrary, BMY, GILD, and other high-quality healthcare stocks will likely benefit greatly from increased earnings, sector rotation, and multiple expansion. These factors will likely be amongst those most responsible for taking quality, undervalued healthcare names much higher.

What Would You Rather Own?

Ask yourself this, when the growth scare returns, would you rather own a FANG like Amazon (AMZN) trading at 95 times trailing earnings, or would you own a company like Biogen, trading at 8.6 times trailing EPS?

High growth, high multiple names like Amazon, Netflix (NFLX), and many others could get cut in half, while ultra-cheap low multiple healthcare stocks like Celgene and others would likely increase in value due to sector rotation and their "recession-proof" business operations.

Healthcare is also Essentially Recession-Proof

Healthcare is a noncyclical sector, and many companies should continue to do extremely well even during times of an economic slowdown or a recession.

People will always need medicines, the sector is highly subsidized, and the high-quality companies in this space are extremely unlikely to see meaningful revenue or EPS declines, even in a slower economic environment. Therefore, the healthcare segment looks extremely attractive here, especially from a long-term perspective.

The Bottom Line

Due to sector rotation, higher-than-expected earnings, and increased demand, I expect many healthcare multiples can expand to about 13-15 times forward earnings estimates over the next 12-18 months.

Other defensive sectors such as utilities currently trade at over 18 times forward projections.

There is no reason why healthcare multiples can't expand moderately from these rock-bottom valuations. After all, historically, many of the underlying names have traded at substantially higher multiples (17-20, or higher).

Therefore, even at 13-15 times estimates, healthcare stocks will remain amongst the cheapest names in the market and are still relatively cheap compared to past healthcare valuations.

So, what would these 5 undervalued stocks look like trading at 13-15 times forward earnings?

Bristol-Myers: current price - $45, price at 13 times forward earnings $57.70, price at 15 times forward earnings $66.60. In percentage terms: gain of 28-48%.

Gilead: current price - $63, price at 13 times forward earnings $90, price at 15 times forward earnings $104. In percentage terms: gain of 43-65%.

AbbVie: current price - $78, price at 13 times forward earnings $122.60, price at 15 times forward earnings $141.45. In percentage terms: gain of 57-81.4%.

Celgene: current price - $93, price at 13 times forward earnings $164.6, price at 15 times forward earnings $190. In percentage terms: gain of 77-104%.

Biogen: current price - $230, price at 13 times forward earnings $388, price at 15 times forward earnings $448. In percentage terms: gain of 69-95%.

All projections are based on consensus estimates, and don't consider the possibility of earnings beats, which are quite typical for many of the stocks mentioned.

Bristol-Myers is great because it provides a stable dividend, and the stock has ample room for upside potential. You can also apply covered call dividend strategy to get stable high double-digit returns with almost no risk.

Gilead and AbbVie are also great companies with substantial upside potential. Celgene and Biogen, while being slightly riskier, have the most upside potential, in my view, but do not offer a dividend.

All companies can be efficiently fused with the covered call dividend program. This essentially means that even if the stock remains flat or moves up slightly, market participants would likely make around 30-50% on positions in one year.

Disclosure: I am/we are long PFE, AMGN, BMY, CELG, ABBV, GILD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.