The health care sector is a hugely appealing place to invest for the long term. That’s because it offers excellent growth prospects, with demand for drugs and treatments likely to increase as the world’s population rises and the emerging world becomes increasingly wealthy.
Furthermore, health care companies tend to deliver performance that is less positively correlated to the macroeconomic outlook or performance of the stock market than their index peers. This means that they have relatively defensive qualities, which can help to boost the performance of a portfolio during a downturn.
However, within the health care space there are a number of niches. For example, GlaxoSmithKline (LSE: GSK) is a pharmaceutical company that develops new treatments for illnesses such as HIV, while Smith & Nephew (LSE: SN) is a wound care and orthopaedic specialist and, as such, is less prone to the ups and downs of the patent cycle. Meanwhile, Advanced Medical Solutions (LSE: AMS) is a smaller wound care specialist which has posted stunning returns of 1600% over the last ten years.
Having a mix of all three within a portfolio can offer a potent mix of diversification and a more enticing risk/reward ratio. And, looking ahead, all three stocks have the potential to deliver excellent total returns.
A superb pipeline
GlaxoSmithKline is focusing on becoming a more efficient business in the coming years. This is good news for its shareholders since it means that profit growth is a realistic prospect even if sales numbers continue to disappoint. And, with the company’s restructuring plans on-track, GlaxoSmithKline is likely to be a leaner and much more profitable business over the medium term, which could positively catalyse investor sentiment in the stock.
In addition, GlaxoSmithKline has a superb pipeline of new drugs, notably via its ViiV HIV division, and could realistically become a bid target. That’s especially the case since a number of global pharmaceutical companies are struggling to grow and, as such, may be enticed by the drugs which GlaxoSmithKline hopes to have on sale over the next 3-5 years. And, with GlaxoSmithKline yielding over 6% and trading on a price to earnings growth (PEG) ratio of 1.3, it seems to hit the income and growth ‘sweet spots’ at the present time.
A very reliable track record
Similarly, Smith & Nephew trades on a PEG ratio of 1.4 and, unlike GlaxoSmithKline, it has a very reliable track record of hitting upbeat growth numbers. For example, its earnings have risen at an annualised rate of 5% during the last five years and, in the long run, rising demand in emerging markets is likely to move this rate of growth higher.
In addition, Smith & Nephew remains a very sound and stable business. It has only modest debt on its balance sheet, with a debt to equity ratio of just 40%. This means that when interest rate rises do occur, its margins are unlikely to be severely squeezed, which should help to keep its pricing competitive and investor sentiment relatively upbeat.
A rapidly growing business
Meanwhile, Advanced Medical Solutions is also a fast-growing business. Its pretax profit stood at £4.3m in 2010 but, next year (i.e. six financial years later) it is forecast to hit £18.4m. That’s a stunning rate of growth and, looking ahead, further increases in its profitability are very much on the cards.
Likewise, dividend growth could be a major catalyst for the company’s shares over the long term. Although Advanced Medical Solutions remains a rapidly growing business, it’s likely that the rate of profit growth will slow somewhat as it becomes more mature. But, with a payout ratio of just 12%, there is considerable scope for its yield of 0.5% to rise in 2016 and beyond.
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Peter Stephens owns shares of Advanced Medical Solutions and GlaxoSmithKline. The Motley Fool UK has recommended GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.