5 Tips for Investing in Health Care in 2016

Health care stocks have soared in recent years, but there’s still room for new investors.

Even with the run-up in health care stocks in recent years, it’s not too late for investors to add a dose of drugmakers, hospitals or related companies to their portfolios for 2016, experts say.

But that’s not to say there aren’t pitfalls to watch out for. Here are five tips on health care investing from investing gurus.

Look for fundamentals. In the health care sector and other industries, Brian Hennessey, a portfolio manager with Alpine Woods Capital Investors in Purchase, New York, looks for companies that have good secular earnings drivers, solid balance sheets and strong cash-flow generation that allow them to pay and grow dividends. Long-term contracts with customers and suppliers and solid management teams that can grow cash flows and dividends are good signs, he says.

Hennessey likes pharmaceutical companies that have patent protection on drugs and biotech companies that have matured enough to essentially be pharmaceutical companies. In addition to hospitals, he likes drug-related services companies like Cardinal Health (ticker: CAH), McKesson Corp. (MCK) and AmerisourceBergen Corp. (ABC). He also likes pharmacy benefits managers like CVS Health Corp. (CVS).

Go for funds. While individual stocks of large, diversified companies like Johnson & Johnson (JNJ), Merck & Co. (MRK) or Pfizer (PFE) are OK, the so-called “story stocks” and individual smaller biotech stocks are much riskier, says Steve Goldberg, partner with Tweddell Goldberg Investment Management in Silver Spring, Maryland. Not even the scientists at those companies, he says, know whether their drugs will make it through Food and Drug Administration trials.

Instead, investors are better off in broad funds that are slightly more invested in health care than the broader market, he says. He likes the Vanguard Healthcare Fund Admiral Shares (VGHAX), the Vanguard Health Care exchange-traded fund (VHT) and Vanguard Dividend Growth Fund Investor Shares (VDIGX).

Focus on the health care law. Companies that operate hospitals, such as HCA Holdings (HCA) and Universal Health Services (UHS), stand to benefit and be able to boost their dividends because of more insured patients coming through their systems and a reduced number of uninsured patients as a result of the Patient Protection and Affordable Care Act, Hennessey says.

The latter were formerly an expense, as many without insurance came into emergency rooms, could not be turned away and sometimes did not pay their bills. The shift to more insured patients means more hospitals can now get paid for work they had been doing essentially pro bono.

One concern for segments of the health care industry has been low pricing under new health care exchanges under President Barack Obama’s health care law, as cooperatives have tried to grab market share by lowering prices for insurance plans, Hennessey says. Amid the pricing pressure, UnitedHealth Group (UNH) is considering pulling back on its marketing efforts for individual exchange products in 2016 and said it would be considering “to what extent it can continue to serve the public exchange markets in 2017.”

If more managed health care companies start pulling out, that could create problems for “Obamacare” because there would no longer be as many people getting insured, Hennessey says. But he calls this “growing pains” and thinks pricing will improve next year as unprofitable cooperatives shut down.

As for UnitedHealth, the company is so large and diversified it has the luxury of not participating in the exchanges and can bide its time until pricing improves, he says.

Hennessey points to Anthem (ANTM) as a managed care provider that stands to benefit under the health care law, as it is one of the biggest providers of Medicaid benefits. There could be more states signing up for expanded Medicaid participation under the law, he says.

Go for dividends. Paying dividends is relatively recent shift for the hospital sector, as previously it was focusing on using cash for growing through acquisitions, Hennessey says.

Biotech also generally doesn’t pay dividends, he says. But notable exceptions include large biotech companies that have matured enough to basically be pharmaceutical companies, such as Gilead Sciences (GILD) and Amgen (AMGN), he says. Both companies have room to continue paying dividends, he says.

Pay attention to politics. As the U.S. health care industry continues moving from a highly privatized system to more universal coverage, investors can’t assume the regulatory landscape is going to be stable, Hennessey says.

Pitfalls to look out for include political headwinds, he says, noting Democrat Hillary Clinton’s recent comments about pharmaceutical costs and health care mergers.

At the same time, Clinton is more favorable toward the Affordable Care Act than Republican opponents of the health care law. “She’s not going to be dismantling Obamacare,” Hennessey says. But “she may be tweaking things.”

By Matt Whittaker

Source: US News and World Report – http://money.usnews.com/money/personal-finance/mutual-funds/articles/2015/12/03/5-tips-for-investing-in-health-care-in-2016