Everyone has experience with the health care industry. When you get sick, you buy medicine. If a sickness or injury is bad enough, you go to the doctor; if it is dire, you may call an ambulance to bring you to the hospital. All of these products and services live within the health care industry.
Because everyone needs quality health care products and services, the market is an absolutely massive one. According to Statista, health care companies generated more than $281 billion in total revenue in the year 2019, and that number is climbing. In fact, the health care sector has a compound annual growth rate of 7.9%.
Any time a market is so massive, there’s plenty of room for big companies to make big profits and funnel those profits to investors. So, it’s not surprising to see that so many people want to invest in health care stocks.
Beyond the money you can make in the health care sector, investments in the space come with a feel-good effect. Investors in the sector sleep well knowing their investing dollars are being used by biotech and pharma companies, as well as health care providers and health insurance providers, to develop therapies and make sure those therapies are available to the people who need them. As such, an investment in a health care stock is as much a philanthropic move as it is a capital one.
But as great as investing in health care stocks can be, it can also be dangerous. Making the wrong investments in the space, known for wide swings in valuations, will lead to significant losses. So, it’s important that you understand the market and what makes it tick before risking your money in the space.
What Are Health Care Stocks?
Health care stocks represent a diverse group of health care companies. The health care category is an extremely broad one, encompassing a wide range of companies from multiple sectors.
- Biotech. All stocks within the biotechnology and pharma sector are also health care stocks. These companies create, manufacture, and market the medicines we take when we’re sick.
- Service. There are also plenty of stocks within the service sector that can also be categorized as health care stocks. For example, health insurance companies, health care providers, and any other company that provides a medical service is included in the health care industry.
- Technology. There are also several technology stocks that fall into the health care category. For example, the companies that create the technologies that make remote doctor’s appointments possible, like Teladoc, are health care companies just as much as they are tech companies. Moreover, application and software companies that create health-related mobile phone apps, companies that store medical data in a HIPPA-compliant way, and companies that produce technologies like thermal imaging for use in medical applications are all in the health care category. Even big tech is getting involved in the health care sector, with companies like Apple, Amazon, and Alphabet all making sizable investments in the space.
Essentially, if the company sells a product or service that has anything to do with keeping people healthy, it is a health care company. So, the health monitoring features on the Apple Watch make Apple a health care company as much as Gilead Sciences’ treatment for hepatitis C makes it one.
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Be Careful With COVID-19 Health Care Stocks
The coronavirus pandemic has been a game-changer in the health care industry and the broader economy. As a result of the COVID-19, people are afraid to leave their homes, leading to a spike in home schooling and remote-learning activities. This has also led to a spike in companies claiming to be working on products geared toward the prevention and treatment of the virus.
Any time there is a large amount of investor interest in any particular space, companies of all sizes will come out of the woodwork to get their hands on the copious investor dollars that are available. That’s exactly what we’re seeing when it comes to COVID-19 stocks.
There are quite a few companies that have viable products and candidates for the prevention and treatment of COVID-19. However, there are also quite a few small companies out there that have said they are working on a COVID-19 product, but have nothing concrete to show for it.
If you plan on investing in the COVID-19 space, it’s important to do your due diligence and make sure that the company you’re interested in has the following:
- An Actual Product. There are tons of companies that say they are working on COVID-19, vaccine candidates, treatment candidates, and personal protective equipment technologies but haven’t announced anything tangible. At this stage in the game, if the company doesn’t at least have something under development, it’s not going to make it in the COVID-19 space, and it represents a health care stock that comes with significant risk.
- Something Outside of COVID-19. Companies that are the strongest investments as a result of COVID-19 are those that had a strong history prior to the pandemic and a great likelihood of being successful once the pandemic is a thing of the past. If the only product the company is working on is in the COVID-19 space, it’s a red flag.
- An Institutional Backing. Although it’s never a good idea to blindly follow the moves of institutional investors, these investors spend their lives doing nothing more than analyzing investment opportunities. If you find a COVID-19 stock you’re interested in, but institutional investors aren’t risking their dollars on it, you shouldn’t risk your dollars on it either.
- Profitability. The health care industry — especially the clinical stage biotech corner of the industry — is not one that’s known for profitability. Beginner investors should only invest in health care stocks that have already generated a profit as clinical-stage biotech companies. Pther companies in the sector that don’t create profits represent highly speculative investments that come with significant risks.
Pro tip: If you’re going to add health care stocks to your portfolio, make sure you choose the best possible companies. Stock screeners can help you narrow down the choices to companies that meet your requirements. Learn more about our favorite stock screeners.
Health Care Stocks Pros and Cons
There are plenty of benefits involved in investing in the health care sector, but there are pros to cons to everything — and health care stocks are no different.
Pros of Health Care Stocks
Investments in health care stocks come with several benefits. Some of the most important to consider when deciding whether to invest in the sector, include:
1. There’s a Wide Range of Opportunities
The health care sector is massive, offering a wide range of opportunities across stocks with wide-ranging market caps that live at various different levels of risk. As a result, regardless of your goals when you make investments, you’ll likely find an opportunity or two that fits well in your portfolio.
For example, if you’re looking for a stable growth stock that pays dividends and comes with a relatively low level of risk, you would likely dive into a blue-chip stock like Johnson & Johnson. This health care stock has a long history of sustained growth and increasing dividends, fitting the bill for exactly what you want.
On the other hand, if you’re willing to take on more risk and want to get in on a company on the ground floor for a potential opportunity to win big in the long run, you may look at Novavax. This company has multiple vaccine candidates under development, some in late stages, and seems to be changing the way we see influenza vaccination while also working on a COVID-19 vaccine candidate.
If you’re somewhere in between and don’t want to take the risk on the ground level, but still want the opportunity for significant gains, you may look at a company like Gilead Sciences. The company has seen great success with its hepatitis C treatment franchise. With work in COVID-19, HIV, and several other ailments, the company may see similar blockbuster success ahead. In the meantime, revenue and earnings growth generated from the early successes of the company greatly reduces the risk.
As you can see, no matter what your needs are as an investor, there’s a strong chance that a health care stock — or group of health care stocks — can assist you in meeting your investing goals.
2. Health Care Stocks Are Interesting
Successful investors will generally tell you they avoid investments in companies that do things they’re not interested in. There’s a good reason for that. To make money in the market, you have to be willing to do research into the companies that you’re buying pieces of.
If you’re interested in what you’re investing in, you’re more likely to do the research that’s required to make effective investments. Conversely, if you’re not interested in the product produced by a company, there’s a possibility that you will cut the research short, not getting the full story, and therefore, you’re incapable of making an educated investment decision.
The vast majority of children have an interest in science and what makes the human body tick. As you grow older, this interest tends to continue. It’s the reason both the Bill Nye the Science Guy and MythBusters TV shows were so popular, even though one was geared toward younger audiences and the other toward adults.
Health care and medicine are highly scientific topics. As a result, you’ll likely find the research into these topics more interesting than research surrounding topics like banking, commodities, or other industries that don’t have the “sexy” factor.
3. There’s a Feel-Good Effect
There’s no other way to say it. Investing in health care makes you feel good. When you invest in a health care stock, you’re investing in a company that has improving the lives of others at its core.
The entire sector is centered around making the sick feel better, improving the quality of lives of patients, and extending the length of life. Those are tall orders, and the heroes in the health care industry fill those orders every single day.
In today’s day and age, socially responsible investing is becoming more popular. Investors are just as interested in the problems their investments address as they are in the money the investments can generate for them. The vast majority of health care investments lend a hand to the socially responsible investing trend.
Cons of Health Care Stocks
Although investing in health care stocks can be a lucrative venture and make you feel good in the process, there are also drawbacks to consider. Some of the most important drawbacks to consider include:
1. Exclusivity Doesn’t Last Forever
In the health care industry — especially the biotechnology side of the industry — exclusivity is important. When a new drug is approved by the U.S. Food and Drug Administration (FDA), the regulatory agency grants an exclusivity period in which the company that receives the approval is the only company that can sell the treatment in the United States.
In general, this exclusivity period lasts for a period of five years. However, for drugs that treat rare conditions or those that treat conditions with no other options on the market, exclusivity periods can be extended to up to seven years.
Once an exclusivity period expires, any other company can sell that therapy under a generic brand name, cutting a deep hole into the revenue generated by the original drug developer. If the company does not continue to innovate and only has one approved treatment, the scars left by generic competition can be painful for the company and its investors, cutting into earnings growth and potentially leading to losses.
2. Clinical Trials Can Go Wrong
Biotechnology companies in the health care industry have an additional hoop to jump through. Before a drug, medical device, or therapeutic agent can make it to market, it needs to be tested in three phases of clinical trials.
Should any of these clinical trials go wrong, the stock that represents the biotech company may experience a dramatic decline in value. This poses an added risk for investors considering buying companies in the clinical-development stage.
3. There Are Several Risky Plays That Look Good
There are quite a few companies in the health care industry that sell a hope and a dream. The problem is that the hopes and dreams are easy to buy into. For example, people understand the global health risks posed by AIDS and can get excited about the prospect of eradicating the disease.
Unfortunately, there is still no cure for the condition.
There are several companies out there working on a solution, and every company on the list will claim that they are onto something big. However, the vast majority of life sciences and biotech companies looking for a solution to this problem are in early development stages.
When news is released that one of these treatments did well in mice, it’s easy to think that the treatment will do well in humans and make it to market. That’s not always the case. Moreover, the road to FDA approval can be a long and costly one, further adding to the risk.
The same can be said for companies creating medical devices or even pioneering new health care services.
As a result, it’s more important than ever for you to do your research to get a full understanding of the company you’re buying into prior to making an investment in the health care industry.
When Should You Invest in Health Care Stocks?
Because there are a wide range of different types of investments available in the health care industry, any time may be a good time to invest in the space. The key here isn’t when to invest in general, but when to invest in which types of health care stocks.
Market Rallies and Economic Booms
When economic times are positive and markets are rallying, cyclical health care stocks are the stocks to buy. Cyclical stocks ebb and flow with economic conditions.
Cyclical health care stocks often work in multiple sectors. For example, according to CNBC, Apple has spent years building internal medical teams. These teams have developed health care software, hardware, and — most recently — health care provider locations.
At the same time, Apple is known for some of the most successful technologies in the world. The company makes the iPhone, iPad, Apple Watch, and several other consumer electronics products, selling billions of dollars worth of its technology every year.
These products are decidedly cyclical. Consumers are more likely to spend thousands of dollars on technology when they are secure in their jobs and have a positive outlook of the United States economy. As a result, an investment in Apple, or another company like it, gives you exposure to the health care sector while allowing you to take advantage of positive economic trends.
Economic Declines and Market Crashes
If you are sick, you’re going to go to your health care provider, buy medicine, and do what you can to get well as quickly as possible, regardless of economic conditions. As a result, the vast majority of health care companies are noncyclical investments.
These are the types of stocks you want to get involved in when economic conditions are declining. Getting out of the stocks that have a heavy correlation to the United States economy and getting into more stable-growth stocks like established health insurance, pharmaceutical, and health care technology stocks protects your portfolio from significant losses.
These stocks even have the potential to experience gains through economic downturns, making them safe-haven options worth considering.
How Much Should You Invest in Health Care Stocks?
Diversification is an important part of most successful investment portfolios. The idea is that, by investing in a wide range of asset classes, sectors, and stocks across the stock market, you have the ability to avoid significant losses on a single investment or a group of investments in a single sector or asset class.
So, how should you go about diversification when it comes to investing in the health care sector?
Consider Your Goals
The vast majority of established health care companies are stable-growth companies. Because their products are needed regardless of the time of year, economic conditions, or geopolitical situation, these are the perfect stocks for buy-and-hold investors.
On the other hand, if you’re looking for a strong income investment or a momentum play, the majority of established health care companies aren’t going to be best.
While some health care companies pay dividends, the average dividend yield in the industry is just 2.28% according to Dividend.com. That pales in comparison to the 3.2% average dividend yield in the technology sector, the 3.9% average dividend yield in utilities, or the whopping 4.9% average dividend yield in the basic-materials sector.
Also, while established health care companies are known for strong long-term growth, they are not known for momentous growth. Riskier, clinical-stage biotech companies may scratch this itch, but there are far less risky plays with which to take advantage of momentum.
Make Sure You Can Dedicate Enough Time
While the health care industry is generally an enjoyable and entertaining industry to research, there is a drawback. Health care is an incredibly convoluted space. There are quite a few working parts. Not to mention, the highly regulated nature of the health care industry adds a deeper level of research that’s required to understand long-term opportunities.
As a result, if you intend to invest in the health care space, it’s important that you have the time to do the research required to get a solid understanding of just what you’re investing in before you risk your money.
It’s also important to keep tabs on new innovation. Due to short-term exclusivity periods, health care companies — even established ones — must continue to innovate to drive growth in the future. Understanding a company’s product-development pipeline requires even more of a time commitment.
Managing a well-diversified portfolio full of health care stocks could be a full-time job. So, you’ll want to limit your health care allocation to the number of stocks that you have adequate time to research, both in performing initial due diligence and keeping tabs on continued innovation.
One way around the daunting research involved with investing in the health care sector is to consider health-care-focused exchange-traded funds (ETFs), mutual funds, or potentially Nasdaq Composite Index funds because the Nasdaq is biotech- and tech-heavy.
Follow the 5% Rule
No matter what sector or asset class you’re interested in, the 5% rule is an important guideline to follow, especially for the beginner investor. The rule suggests that no more than 5% of your overall investment portfolio should be used for any single investment. You should also never spend more than 5% of your overall portfolio dollars on combined high-risk investments.
Following this rule, let’s say you are interested in Johnson & Johnson, an established name in health care that is known for consistent growth that you believe will continue to provide tremendous growth.
Say you have $10,000 in your investment portfolio. Based on the 5% rule, you can invest up to $500 in Johnson & Johnson. Because you believe the stock will continue to produce compelling growth, you decide to invest the entire $500 in the stock. However, if you had some questions about the company’s ability to continue growing, you may invest $250 to gain exposure but limit risk.
Following the same example, let’s suppose you’re looking at five clinical-stage companies in the early stages of product development that you believe have real potential. Because these are all high-risk opportunities, the rule suggests you could invest $100 into each company, ensuring that the combined total value of these riskier investments would not exceed 5% of the overall value of your portfolio.
The health care industry is booming and filled with opportunities for investors. Not only do these stocks have the potential to generate gains within your portfolio, but they have an added benefit: the feel-good effect of knowing that the company you’re funding is helping people live healthier lives.
On the other hand, not all stocks are created equal. When investing in the health care sector, be sure to do your due diligence and keep up with the companies you’ve made investments in. Short exclusivity periods and a highly regulated environment make for added risks to consider.
Nonetheless, by doing your research, keeping tabs on your investments, and being a generally educated health care investor, the potential rewards are compelling.
Do you invest in health care? Do you find science and medicine to be an interesting topic?