These Healthcare Companies Aren't Sick
Nikhil is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There's plenty of value in the healthcare sector right now, it just isn't being realized. Why might that be? It's likely due to a lack of a major catalyst. Things like this tend to happen in crazy market conditions like those of today. Entire industries become undervalued due to mere speculation and investor fears, and they're annoying to sit on because value isn't realized. Look at financials and you can see the effect quite clearly.
In the healthcare industry, however, I see a bunch of big boys, large cap companies with oodles of free cash flow, who are gently undervalued to conservative prospects because of market conditions. These are companies in whose prospects I have no doubt. Why won't these companies languish around like the financials of yesterday(and today!)? Truth is they might, but healthcare is a defensive sector, and unlike the tricky financial industry, it's easy to tell that the river of cash flow coming into these companies isn't going anywhere. These healthcare companies don't have a disease, and once the market figures that out, I expect a diversified bet on the top dogs in the sector will do quite well.
Thermo Fisher Scientific(NYSE: TMO), a company that offers a wide portfolio of lab equipment products, is one example. A $19 Billion dollar company with a large swath of the market (I see their products in lab everyday) and it's only selling for 13.5x last year's Free cash Flow. Thermo Fisher isn't even one of the big three healthcare giants I wanted to point out in this article, but the company might as well be. Thermo Fisher Scientific's products are everywhere, it's cash flow is stable and growing, and it's growth in the future is set to come from Diagnostics (an idea that I will be coming back too). I don't like recommending companies with such recent S&P downgrades, so I have to leave Thermo Fisher off my top 3 Healthcare Giants for this market.
My Top 3 Healthcare Giants for This Market
| Companies | CROIC(Vuru.com) | Net Profit Margin(Vuru.com) | Dividend Yield |
| Medtronic(NYSE: MDT) | 16.68% | 21% | 2.75% |
| Becton, Dickinson and Co. (NYSE: BDX) | 17.66% | 16.23% | 2.42% |
| Baxter Inc. (NYSE: BAX) | 19.68% | 16% | 2.45% |
These are clearly all healthy companies (see what I did there?). I placed my focus on these three metrics because I believe these reveal a lot about each company's strengths and the power of the industry's cash flow. CROIC (Cash Return on Invested Capital) measures the return that a company is receiving on all of their investments (including investments from both equity and debt). While the more traditional metric, Return on Equity, is more common, it can easily be fooled by share repurchases or debt increases to reduce equity instead of increasing income. Generally, a CROIC above 10% is considered great, so a CROIC above 16% and approaching 20% is a fantastic use of a company's capital. All three of these company's are making stellar investments. Moreover, they all have high profit margins. According to Fool.com, the industry Net Profit Margin is 14%, so all of these companies are running above average. Finally, our goal is to beat the market right? You won't be left behind. While the S&P 500 yields 2%, these companies average around 2.5%, so my diversified bunch will have a 0.5% edge. Not saying much, but you take what you get.
The Margin of Safety
I believe that this group as a whole has around a 30% margin of safety, and I am confident that in time these three companies will beat the market as a group. Without a real competitive advantage, however, you can't expect these companies to shine until the market calms down. Selling options is a real possibility with these companies. While it takes out the upside possibility if there is large growth, it will give you a good supplemental income, and I don't think growth will occur anyways, so I omitted them from my intrinsic value estimates. These companies are betting on Diagnostics as a way to growth, but with so much competition, I think the market is scared none of the growth will materialize. By the time the market realizes that with current stable cash flows alone, these companies are plenty undervalued, share repurchases will be well underway and I believe things will go up from there.
shamapant has no positions in the stocks mentioned above. The Motley Fool owns shares of Medtronic. Motley Fool newsletter services recommend Becton, Dickinson and Co. and Thermo Fisher Scientific. 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.If you have questions about this post or the Fool’s blog network, click here for information.
