Healthcare: XLV Survey For October

ETFS

This article series shows every month a dashboard with aggregate industry metrics in healthcare. Most of the companies used to calculate these metrics are holdings of the Health Care Select Sector SPDR ETF (XLV). Therefore, this is also a top-down survey of XLV.

Shortcut

If you are used to this dashboard series or if you are short of time, you can skip the first paragraphs and go to the charts. However, reading everything once is necessary if you want to use the metrics for stock picking purposes.

Base Metrics

We calculate the median value of five fundamental ratios for each industry: Earnings Yield (“EY”), Sales Yield (“SY”), Free Cash Flow Yield (“FY”), Return on Equity (“ROE”), and Gross Margin (“GM”). Our calculation universe includes large companies in the U.S. stock market. The five base metrics are calculated on trailing 12 months. For all of them, higher is better and negative is bad. EY, SY and FY are medians of the inverse of Price/Earnings, Price/Sales and Price/Free Cash Flow. They are better for statistical studies than price-to-something ratios, which are unusable or non available when “something” is close to zero or negative (for example, companies with negative earnings). We also calculate two momentum metrics for each group: the median monthly return (RetM) and the median annual return (RetY).

We use medians rather than averages because a median splits a set in a good half and a bad half. A capital-weighted average is skewed by extreme values and the largest companies. Our metrics are designed with a stock-picking mindset, not for index investing.

Value and Quality Scores

We calculate historical baselines for all metrics. They are noted respectively EYh, SYh, FYh, ROEh and GMh, and they are calculated as the averages on a look-back period of 11 years. For example, the value of EYh for Pharma & Biotech in the table below is the 11-year average of the median Earnings Yield in a universe of pharmaceutical and biotechnology companies.

We define the Value Score (“VS”) as the average difference in % between the three valuation ratios (EY, SY, FY) and their baselines (EYh, SYh, FYh). The same way, the Quality Score (“QS”) is the average difference between the two quality ratios (ROE, GM) and their baselines (ROEh, GMh). The formulas are below.

VS =100*((EY-EYh)/EYh+(SY-SYh)/SYh+(FY-FYh)/FYh)/3

QS =100*((ROE-ROEh)/ROEh+(GM-GMh)/GMh)/2

The scores are in percentage points. VS may be interpreted as the percentage of undervaluation or overvaluation relative to the baseline. A positive score points to undervaluation, a negative one to overvaluation (positive is good, negative is bad). This interpretation must be taken with caution: the baseline is an arbitrary reference, not a supposed fair value. The formula assumes the three valuation metrics are of equal importance.

Current data

The next table shows the metrics and scores as of last week’s closing. Columns stand for all the data named and defined above.

VS

QS

EY

SY

FY

ROE

GM

EYh

SYh

FYh

ROEh

GMh

RetM

RetY

HC Equipment

-54.58

0.68

0.0179

0.1472

0.0169

14.19

63.69

0.0385

0.3201

0.0386

14.41

61.91

4.85%

14.79%

HC Providers

-6.20

-17.09

0.0542

1.1620

0.0718

13.47

20.06

0.0546

1.6330

0.0647

16.16

24.35

5.04%

20.07%

Pharma & Biotech

-13.35

37.12

0.0377

0.1998

0.0361

31.72

82.88

0.0419

0.2855

0.0361

18.62

79.75

1.29%

34.15%

Life Science Tools

-40.50

-2.19

0.0217

0.1756

0.0213

15.27

54.11

0.0337

0.3298

0.0350

15.38

56.17

4.90%

54.15%

Value and Quality chart

The next chart plots the Value and Quality Scores by industries (higher is better).

Evolution since last month

Since last month, the value score has deteriorated in all groups due to price action.

Momentum

The next chart plots momentum data.

The best performing S&P 500 stocks in this sector in 1 month are: Anthem Inc. (ANTM), Centene Corp. (CNC), Catalent Inc. (CTLT), IDEXX Laboratories Inc. (IDXX), and Steris Plc (STE).

Dashboard List

The list below was published for Quantitative Risk & Value subscribers several weeks ago based on data available at this time. These stocks were in the good half among their peers for 3 valuation ratios and ranked on higher return on equity. This is not investment advice. Do your own research before buying.

ANTM

Anthem Inc.

BIIB

Biogen Inc.

CHRS

Coherus BioSciences Inc.

DVA

DaVita Inc.

ENSG

Ensign Group Inc.

INVA

Innoviva Inc.

MOH

Molina Healthcare Inc.

SUPN

Supernus Pharmaceuticals Inc.

VIVO

Meridian Bioscience Inc.

WAT

Waters Corp.

Interpretation

“Pharma and biotech” is slightly overvalued, but far above the baseline in quality. It is definitely the most attractive group in the healthcare sector. Some popular ETFs in this group are IBB, XBI, XPH and ARKG. For healthcare providers, the value score is close to the historical baseline, but the quality score is lower. Life Science Tools and HC equipment are significantly overvalued. It is not justified by their quality scores, close to the baseline. Life Science Tools is the best-performing group regarding the 12-month median return.

We use the table above to calculate Value and Quality Scores. It may also be used in a stock-picking process to check how companies stand among their peers. For example, the EY column tells that a large pharma/biotech company with an Earnings Yield above 0.0377 (or price/earnings below 26.53) is in the better half of the industry regarding this metric. A Dashboard List is sent every month to Quantitative Risk & Value subscribers with the most profitable companies standing in the better half among their peers regarding the three valuation metrics at the same time.

Our cheap stock lists are designed to outperform their sector benchmarks on the long-term. Quantitative Risk & Value (QRV) provides you with a realistic quantitative approach of market risk and sector-oriented value. Get started with a two-week free trial and see how QRV can improve your investing decisions.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long in healthcare stocks not quoted in this article.

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