Healthcare: Stock selection increasingly important

Despite healthcare valuations increasing, we still see some stocks as undervalued, with opportunities in the drug and device areas.

Damien Conover, CFA 7 July, 2016 | 5:00PM

In looking at the core pillar of economic moats of innovation in healthcare, drug companies are rapidly increasing the speed of generating excellent clinical data in areas of unmet medical need, particularly oncology and immunology. Advances in immuno-oncology drugs are reaching the market at half the time of drugs developed a decade ago, partly due to major advancements in science, but also due to more accommodative healthcare regulatory groups.

We expect the shift to continue and to increase drug-development productivity and strengthen the moats for drug companies, especially as the productivity gains are in areas of development that carry strong drug pricing power and steep launch trajectories. Although the patient populations tend to be smaller in these specialty areas, the strong pricing power can easily turn the drugs into blockbusters. In immunology and oncology, drugs tend to carry annual prices of US$25,000 and more than US$100,000, respectively, supporting major markets despite smaller patient incidence rates as compared with historical areas of focus such as high blood pressure.

On the political side, although we expect the rhetoric on lowering drug prices will probably continue as presidential candidates vie for voters, we don't see any major shifts in U.S. drug prices over the next several years. Nevertheless, we expect drug pricing concerns to cause increased volatility in pharmaceutical and biotechnology stocks. However, without a major structural reform and a willingness by patients and doctors to limit treatment options, we don't see any major changes in U.S. drug prices.

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About Author

Damien Conover, CFA

Damien Conover, CFA  Damien Conover, CFA, is director of healthcare equity research and equity strategy for Morningstar.

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