President-elect Donald Trump recently commented in a Time magazine interview that he'll bring down drug prices. Apparently, the president-elect's remarks were not well received by the market, because they led to an immediate and initial significant drop in the stock prices of many healthcare-related companies.
However, I feel it's important to note that these price drops were not the direct result of an actual deterioration in fundamentals. Instead, the price drops occurred as a result of a perceived negative future impact on fundamentals. Time will tell whether Donald Trump can actually bring drug prices down and whether or not there will be a real impact on the operating results of many healthcare companies.
Furthermore, since the original negative reaction to this news (I would call it noise), healthcare stocks are rallying. More importantly, many of them are rising at a much higher percentage rate than the market. In the short run, stock price movements can be quite irrational and easily incited by knee-jerk emotional responses. This often creates incredible long-term investment opportunities, especially on fundamentally sound companies.
BeGreedy When Others Are Fearful - But Be Smart About It
Healthcare stocks have generally been poor performers in calendar year 2016. I suggest that this weak performance, especially relative to high-quality, fundamentally sound healthcare stocks, can be somewhat attributable to political uncertainty regarding the future of healthcare. On the other hand, political uncertainty manifesting in 2016 could also be looked at as the catalyst that is bringing healthcare stocks that were overvalued in 2015 down to fundamentally justified levels.
This speaks to how fickle market prices can be. Yesterday's heroes (healthcare stocks) are becoming today's villains. After all, it's quite common that many investors love stocks that are going up in price and tend to hate stocks that are going down in price. But I contend that stock price action alone rarely tells the whole and complete story. It is only when stock prices are measured relative to fundamental values that the truth can be found.
Consequently, when I am looking for stocks to buy, I am most concerned about measuring important fundamentals, such as earnings, cash flows and dividends. I love stocks whose earnings, cash flows and dividends are rising, but only when their prices are in alignment with fundamental values. Stated more plainly, I only like a stock when its price is rising, while simultaneously being supported by fundamental value.
On the other hand, I like it even better when the stock price is falling when earnings cash flows and dividends are rising. However, the recent direction of stock price movement is not the primary factor that will attract me to a stock. Instead, I am most focused on attempting to ascertain the intrinsic value of any company I am interested in. Therefore, when it comes down to price, my primary questions are - is the stock trading at fair value, or preferably below fair value?
But perhaps more importantly, I tend to only fall in love with a stock when its price is falling, while its earnings, cash flows and dividends are increasing. This is when I consider a stock truly worthy of my affection. No matter how much I admire the business behind a stock, if the market is pricing it excessively, it will never get my attention.
But when I like a strong and sound business, and I am fortunate enough to discover it when it is out of favor in the market, that is when I become enamored. I believe this speaks to the wisdom supporting Warren Buffett's sage advice - to be greedy when others are fearful and fearful when others are greedy. I believe there are many high-quality dividend-paying healthcare stocks that are currently fitting that bill. Below are five examples that I consider worthy of current consideration and a more comprehensive research and due diligence effort.
5 Attractively Valued Healthcare Sector Dividend Growth Stocks
These five dividend growth healthcare stocks are currently trading at very attractive fundamental valuations. As a result, they all reflect high earnings and cash flow yields. This implies that their valuations are attractive relative to their fundamental values. The following portfolio review lists them in order of highest current dividend yield to lowest.
Moreover, although all of these healthcare stocks would qualify as dividend growth stocks, there are options within this group that might be attractive for most every dividend investor's relative objectives. Within this group, you have high yield with low growth, moderate yield with above-average growth potential and above-market yield with above-market growth potential. Consequently, whether it's maximum current income or maximum total return, each dividend investor might find something of interest to them within this group.
If a Picture's Worth 1000 Words, How Many Is A Video Worth?
As regular readers of my work will attest, I always include pictures of F.A.S.T. Graphs™ in my work. However, although the pictures often tell compelling stories, they have shortcomings because they are what I refer to as "dead graphics." As a result, I often get questions such as: why did I pick a certain time frame? Or why did I utilize a certain metric?
The simplest answer I can offer is that I try to include graphics that support and/or reflect the thesis behind the points I am attempting to make. Consequently, with this article I'm experimenting with utilizing a video where I go through my analysis utilizing live, fully functioning F.A.S.T. Graphs™.
The following video includes a brief initial fundamental analysis on the following five fairly valued healthcare selections: AbbVie Inc. (NYSE:ABBV), AmerisourceBergen Corporation (NYSE:ABC), Amgen Inc. (NASDAQ:AMGN), Cardinal Health Inc. (NYSE:CAH) and Teva Pharmaceutical Industries (NYSE:TEVA). This video represents preliminary research that indicates the worthiness of conducting a more comprehensive research and due diligence effort.
Summary and Conclusions
If you're a long-term investor, as I am, investing in great businesses at sound and attractive valuations is an extremely important consideration. When you invest in a great business at a sound valuation, you mitigate your long-term risk, and simultaneously enhance your potential for greater long-term performance.
Additionally, if you're a long-term investor focused on generating a passive and growing income stream, then valuation is even more relevant. Investing in a great business at a sound valuation ensures that you will purchase more shares than you would at a higher valuation. In essence, this means you are efficiently investing your hard-earned capital in a prudent manner. Since dividends are paid on the number of shares owned, this will lead to a greater level of dividend income presently and into the future.
Investing when valuation is sound allows you to effectively participate in the future growth of the business you are purchasing. When you overpay for a great business, as long as you are not completely reckless, you are still likely to make a decent return over time. However, by paying too much, you limit your ability to participate in the company's long-term growth. In the longer run, a company's stock price will eventually gravitate to fair value, as illustrated in the video above. Consequently, overpaying for a stock initially reduces your opportunity to participate in the company's growth potential.
Finally, when you can purchase a great company when it is undervalued, you leverage your upside while lowering your risk. Therefore, not only do you effectively participate in the company's future growth, you also stand to receive a bonus of sorts. Instead of just participating in the company's growth, you also have the opportunity for P/E ratio expansion. Simply stated, not only are you purchasing more future earnings based on growth, but you also have the opportunity to see those greater future earnings capitalized at a higher multiple. I call this natural leverage.
I believe each of the healthcare companies on this list currently provides such an opportunity. However, my position is preliminary based on current valuation and current expectations for future growth of each of these companies. In other words, I offer each of these companies as worthy prospects for a more comprehensive research and due diligence effort. There are choices in this list for most every investment objective. I leave it up to each reader to decide whether any of these selections are worthy of future consideration and research.
Disclosure: Long ABBV,ABC,AMGN,TEVA at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.