Healthcare-Focused Hedgie Bullish on These Stocks

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To say that William Leland Edwards of Palo Alto Investors invests heavily in healthcare stocks would be, well, a bit of an understatement. The fund’s positions read like a pharmaceutical sales rep’s resume, with the top five positions, more than 50% of the entire portfolio, all coming from the biopharmaceutical sector. Mr. Edwards has no medical training and does not hold a degree in biology or chemistry. But what he does have is a knack for picking some of the best performing stocks in this sector of the market.

The key to watching hedge funds

It's always crucial to look at hedge fund sentiment for its market-beating potential, so let’s look at the top five positions in the Palo Alto Investors equity portfolio:

At number one is Onyx Pharmaceuticals (NASDAQ: ONXX), which develops treatments for liver, kidney and stomach cancer. Earlier this year, Onyx, along with Bayer, won expanded FDA approval for Stivarga, a treatment for stomach cancer. The news helped take some of the sting out of Onyx’s disappointing 4Q earnings, which reported a 19% drop in revenue, a 22% increase in costs and a sharp decline in yearly earnings from -$0.66 to -$2.50. Stivarga could potentially earn Onyx and Bayer as much as $1.3 billion annually.

Second on the top five is Cyberonics (NASDAQ: CYBX), a medical-device manufacturer that develops implantable devices providing neuromodulation therapy for the treatment of epilepsy and treatment-resistant depression. Cyberonics recently reported 1Q earnings demonstrating that the company continues to show consistent revenue growth while keeping R&D costs contained; net sales were up 15%, and income from operations rose 25%. Recent insider selling of the stock pressured share prices and the stock is currently trading towards the bottom of its 52-week range of $36.25 to $56.73.

Biotechnology company Viropharma (NASDAQ: VPHM) comes in at number three. Although the debt/equity ratio for this company looks good, its trailing earnings ratio is a shocking 303x versus the industry average of 61x. And analysts warn that because the patent protection on some of its big earners, such as Cinryze, is limited, the growth potential isn’t very encouraging. Since late last year, the stock has been moving in a sideways trend with a slightly lower bias, unable to break resistance at $25.55.

The best of the rest

Coming in fourth on the list is United Therapeutics (NASDAQ: UTHR), of which Palo Alto holds the largest position at 1,208,711 million shares. The company recently reported very strong earnings – revenue was up for 2012 from $195 million to $244 million, which boosted earnings to $1.65 per share vs $0.79.

The stock is also cheap compared to its competitors in this sector, such as Novo Nordisk and Roche Holding. Since adding United Therapeutics to the portfolio during 2Q 2011, Edwards has increased his position in the company by 140%. Judging by the performance of the stock – it’s up 14% on the year – it appears to have been a smart bet.

Last is Questcor Pharmaceuticals (NASDAQ: QCOR) at 2.2 million shares. The biopharmaceutical company develops drugs for the treatment of autoimmune and inflammatory disorders such as multiple sclerosis. Fourth quarter earnings were very strong for Questcor as revenue jumped 133% and net income was up a staggering 148%, largely on the sale of Acthar, used to treat MS. Unfortunately, the financial strength of the company has been undermined recently by restrictions on Acthar. Blue Cross/Blue Shield of Michigan as well as Aetna restricts reimbursement of the treatment if it is used for anything other than infantile-spasms. And analysts worry that other insurers are likely to follow suit, which could ultimately be the death knell for Acthar. Since the start of the year, Questcor has barely moved off the $25.50-$36.54 range.

A nice niche

William Edwards seems to have found a niche in the healthcare sector with biopharmaceutical and biotech companies. This limited strategy can often be less profitable than allowing for other sectors with greater growth potential. Judging by the lackluster performance of some of these stocks, branching out might not only provide diversity, but profitability as well. Check out the fund’s full $853 million equity portfolio.

This article is written by Amy Thielen and edited by Jake Mann. Insider Monkey's Editor-in-Chief is Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article.  The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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