The healthcare sector followed the broader market lower in the first quarter, but for investors considering ETFs, such as the Health Care Select Sector SPDR ETF (NYSEArca: XLV), the good news is that valuations on the sector are now attractive.
The largest healthcare ETF by assets, XLV seeks investment results that correspond generally to the Health Care Select Sector Index. The index includes companies from the following industries: pharmaceuticals; health care equipment & supplies; health care providers & services; biotechnology; life sciences tools & services; and health care technology.
“We view the healthcare sector as undervalued with the market pullback due to the coronavirus outbreak,” said Morningstar analyst Damien Conover in a recent note. “While we may reduce our valuations in healthcare to account for near-term challenges, we expect only modest changes. Our coverage trades at a discount to our overall estimate of intrinsic value, with the median price/fair value at 0.86. Given the market pullback, we see more buys in the sector, with over half of our coverage rated 4 or 5 stars.”
Furthermore, the healthcare sector appears cheap relative to the broader market as this segment has underperformed the run in the S&P 500. Healthcare stocks were among the second weakest performers among the 11 major sectors on the benchmark index. Looking ahead, healthcare companies are projected to generate annual earnings of 9% and revenue growth of 14%, the highest of all sectors in the S&P 500, according to FactSet data.
As Conover points out, investors still must weigh the impact of the coronavirus on the healthcare sector and that impact could turn up one of two scenarios.
“On the coronavirus, our base case calls for a strong rebound in 2021 following a recession in 2020, which should have only a modest impact on healthcare valuations,” said the analyst. “However, if the coronavirus exerts a sustained impact on the economy, with significantly higher numbers of patients unemployed and uninsured or underinsured, this could reduce healthcare demand to a greater extent.”
Previously, investors embraced healthcare stocks for the sector’s growth and defensive characteristics, providing investors with yields and valuations that are less stretched than other yield-producing stocks like utilities. Some market observers believe the sector’s selloff is overdone and that healthcare stocks could be poised to bounce back.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.