Healthcare Stocks: Four Questions for the Recovery
Disappointing returns for healthcare stocks through the market’s recovery from the pandemic have raised concerns about the sector. But there’s still plenty of promising growth potential to be found. These four questions can help investors identify areas of interest.
Since the pandemic began, many investors have paid close attention to the healthcare sector. Yet global healthcare stocks have trailed the broader market since the recovery from the COVID-19-related crash began in April 2020 and in the year to date (Display).
Why the underperformance? First, the sector was affected by a rotation into more economically sensitive industries and out of more defensive industries such as healthcare as investors positioned for an economic reopening post COVID-19. Second, unprofitable small- and mid-cap biotech companies have sold off this year, following strong but volatile gains in 2020. Lastly, rising interest rates have suppressed gains for growth stocks in general—including healthcare—which tend to benefit from lower discount rates. But these trends don’t undermine the long-term appeal of innovative healthcare companies with strong business fundamentals, in our view. The following questions can help guide the way to attractive opportunities in the sector.
1. How has the development of COVID-19 vaccines changed the healthcare industry?
Historic efforts to develop COVID-19 vaccines have had two huge effects on the industry. First, the success of mRNA technology has added an important weapon to drugmakers’ arsenals. We’ve learned from the pandemic that this new technology can be scaled up quickly to deliver a highly efficacious vaccine. It won’t be successful wherever it is applied. But we can look forward to new mRNA-driven efforts to develop vaccines for influenza—which has similarities to COVID-19—and also potentially for malaria, for HIV and in oncology.
Second, drug development has accelerated. The urgency of COVID-19 vaccines triggered innovations to clinical trials that will be applied more broadly. For example, instead of having patients come into hospitals for tests, we believe that some clinical trials will be able to utilize new technologies to monitor trial subjects remotely, effectively decentralizing the clinical trial process. Regulators have also shown they can cut red tape and hasten processes. Time-to-market for drug development may improve from the current standard of seven to 10 years by about a year or two, in light of these two trends.
2. What do the Biden administration’s policies mean for the US healthcare market?
Since President Biden’s election, there’s been quite a bit of talk about what policies he might apply to the healthcare sector, particularly on drug pricing or health insurance. So far, there haven’t been signs of major healthcare initiatives. Even within the Democratic party, there’s formidable opposition to major drug pricing reform such as reference pricing, which would link US drug prices to what’s being charged in Europe, or allowing the government to negotiate drug prices. Efforts to waive patents on COVID-19 vaccines to help reduce costs for emerging markets are also stuck. This requires international consensus, and Germany has recently opposed proposals to waive patents. So overall, we don’t expect any extreme policy changes for the healthcare sector under the new administration, which reduces policy risk for investors.
3. Does an ESG focus identify unique risks or opportunities for healthcare companies?
Integrating environmental, social and governance (ESG) factors in an analysis of healthcare companies is becoming increasingly important for equity investors. Since healthcare is an industry that has a profound impact on society, there’s a growing focus on the value of care provided for patients and communities. We believe companies that improve the value of care delivered make a positive impact on the healthcare system, which positions them well for growth in an era of rising healthcare costs and increased government involvement.
The value of care can be improved by decreasing the cost of service, increasing the benefit to patients or both. Another way to measure value is to connect healthcare with social determinants of health, such as housing, age, and community and education, which can help reduce adverse outcomes. Engaging with companies to increase the value delivered to patients is an effective ESG framework for investing in the healthcare sector, in our view.
For example, by focusing on value-based outcomes, UnitedHealthcare has shortened the length of hospital stays per case by 40% and lowered the mortality rate for patients with congenital heart disease by 41%. Patients who have used the company’s cost and wellness transparency resources have paid nearly 30% less than patients who did not. Edwards Lifesciences produces heart valves that are much cheaper than competitors’, which fosters shorter recovery times and helps people live longer. These examples show how a value-based ESG approach focused on patient benefits can also create better business outcomes for companies—and support returns for investors.
4. What are the latest trends in healthcare that deserve investor attention?
Diagnostics is an exciting segment of the industry. The pandemic taught us the hard way that a more sophisticated testing infrastructure could have helped prevent the spread of COVID-19. So, there will be increased efforts—particularly by governments—to develop preventative diagnostics capabilities. We’ll see significant investment in surveillance and tracking systems.
Efforts to bring medical care closer to the home are growing. The more you can keep people out of the hospital and intervene earlier, the better it is for the patient and for society. Technology will also be used more broadly, for example, to identify patients who are at risk of a bad outcome, which can help determine the sequence of care.
Data analytics, too, are becoming more commonplace to improve outcomes in innovative ways. For example, data analytics can help surgeons refine their skill set and understand where their technique could be better.
These trends are creating fertile ground for equity investors. But don’t be blinded by science; exciting drugs in development and new technologies on their own aren’t good guides to investing success, in our view. Focusing on business fundamentals—balance sheets, competitive advantages, cash flows and profitability—is the best way to find innovative healthcare companies that are well positioned to deliver long-term returns to equity investors in a rapidly evolving post-pandemic world.
Vinay Thapar is Portfolio Manager and Senior Research Analyst—US Growth Equities and International Healthcare Portfolio at AllianceBernstein (AB).
Ryan Oden is an ESG Research Analyst of Equities at AB
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