The healthcare sector is a vast and diverse industry that encompasses many different sub-industries, including pharmaceuticals, medical devices, health insurers, and hospitals, each with unique dynamics. Several variables impact investments in this sector, such as demographic trends and reimbursement rates.
To fully comprehend the underlying drivers of healthcare investments, a multifaceted approach is necessary. Investors can benefit from investing in the overall healthcare sector or specific industries within it.
This article aims to provide a detailed overview of the differences among various healthcare industries and the key metrics investors should consider before investing.
Understanding the complexities of healthcare investing is critical for investors to make informed decisions. With so many different industries and variables to consider, investors need a comprehensive understanding of the sector to identify promising opportunities.
Healthcare
Healthcare refers to the prevention, treatment, and management of illness and injury, as well as the promotion of physical and mental well-being.
Trends in the Healthcare Sector
The healthcare sector is a constantly evolving industry, with many trends that can impact its various industries. When investing in healthcare companies, it’s important to consider the prevalent trends that can have implications for different areas within the sector. Here are some of the key trends to keep in mind:
Demographics
Demographics play a significant role in healthcare trends. As the population ages, there is an increasing demand for healthcare services, particularly in areas such as home healthcare and assisted living facilities. This demographic shift is expected to continue, creating opportunities for healthcare investors.
Technology
technological advancements are rapidly changing the healthcare landscape. Digital health solutions, such as telemedicine and electronic health records, are becoming increasingly prevalent. This trend is expected to continue, creating new opportunities for healthcare companies that can leverage technology to improve patient outcomes.
Cost
Healthcare costs continue to rise, putting pressure on payers, providers, and patients alike. This trend is expected to continue, as the underlying drivers of healthcare costs are difficult to address. Investors should be aware of the potential impact of rising costs on healthcare companies and the broader sector.
Regulatory
Regulatory changes can have a significant impact on the healthcare industry. Changes to the Affordable Care Act, for example, can impact the profitability of health insurers and hospitals. Investors should stay up-to-date on regulatory changes and their potential impact on the companies in which they invest.
Preventative care and wellness
There is an increasing focus on preventative care and wellness. Healthcare companies that can help patients manage chronic conditions and maintain good health are likely to be in demand. Investors should consider companies that are focused on preventative care and wellness, as these areas are expected to continue to grow in importance.
Global Reach of Disease
The global reach of diseases such as COVID-19 and the Ebola virus highlights the need for effective public health policies and strategies. These challenges drive innovation and investment in the healthcare sector, as well as increase the demand for medical equipment, testing supplies, and vaccines.
Personalized Medicine
Advances in genetics, molecular biology, and data science are driving the development of personalized medicine, which tailors medical treatments to an individual’s genetic makeup and medical history. This trend has the potential to revolutionize healthcare by improving patient outcomes and reducing healthcare costs.
Pharmaceuticals
The pharmaceutical industry is a crucial component of the healthcare sector. It involves the manufacturing of drugs for the treatment and prevention of various diseases and medical conditions. Companies in this industry, both pharmaceutical and biotech, spend a significant portion of their revenue on research and development (R&D) to discover new compounds.
However, the “hit ratio” is very low due to the difficulty and tediousness of discovering new compounds. When investing in drug companies, there are several key factors to consider:
- the underlying disease or condition that a specific drug treats
- the number of people affected
- the number of compounds currently available
- the process of discovery and coming to market, specifically the rigorous clinical trials required by the Food and Drug Administration (FDA)
- the availability of substitutes, including generic versions of drugs
- patents
- the overall marketing framework, which may include the revenue or profit-sharing agreements with other companies
The pharmaceutical industry is heavily influenced by clinical-trial data, and surprises about the outcomes of this data can have a significant impact on stock prices. Positive surprises, such as better-than-expected clinical data or faster time to market, can cause stocks to appreciate significantly in a short period. Conversely, negative surprises can have the opposite effect.
In addition to clinical-trial data, aftermarket data such as the number of prescriptions written, market share, FDA warnings, or the loss of a patent can also affect investments in this industry. Therefore, active monitoring is crucial for investors in the pharmaceutical industry.
Who Foots the Bill?
Health insurers play a crucial role in the healthcare industry by paying the bills for medical services. Companies can purchase health insurance in two ways: by assuming the risk of paying all the bills or by allowing the health insurer to assume the risk. This choice can affect a company’s risk and profitability.
The underwriting skills of health insurers play a critical role in their profitability. The better the underwriting, the lower the medical costs relative to the premium received from the purchasing company.
Therefore, investors should pay attention to the medical cost ratio, which is a key ratio reported by health insurers. It is important to look at this ratio as a trend analysis. The medical loss ratio is also a crucial ratio that should be considered, as lower ratios are better.
Investors should look for a company with conservative, trustworthy management because timing mismatches between when medical services are consumed and when bills are paid can occur. It is also important to review proper liability reserves.
Stocks of health insurers are generally more stable and less susceptible to surprises compared to drug stocks. However, it is important to follow government regulations, especially bills related to Medicare and Medicaid funding, as the U.S. government is the single largest purchaser of healthcare services.
The House Ways and Means Committee is an important part of the government that affects Medicare legislation.
Moreover, investors should be aware that stocks in the healthcare industry may react to changes in party control of the government. The Democratic Party is often perceived as less friendly to healthcare companies than the Republican Party.
Facilities
Healthcare facilities, including hospitals and clinics, play a crucial role in the U.S. healthcare system. It is mandatory for facilities with an emergency room to treat any individual walking in, irrespective of whether they have health insurance or not. This law has led to intense competition for hospitals from free-standing clinics and speciality hospitals, which are not obliged to provide services to everyone.
Clinics can choose their patients and receive higher payments from insurance companies, while hospitals are faced with bad debts, which can impact their profitability. Investors focus on the bad-debt ratio while analyzing hospitals.
Cost control is a crucial factor for hospitals’ profitability, and many of them are yet to incorporate electronic medical records, proper purchasing, and operating systems into their standard operations, although the trend seems to be changing.
Hospitals have to manage several cost centres, and controlling costs can be a daunting task. Hospitals that do this well and use computer systems to manage their operations tend to be considered the best managed.
Hospitals that recruit specialist physicians, such as neonatologists, can increase EBITDA (earnings before interest, taxes, depreciation, and amortization) per bed, as speciality medical practices generally receive higher payments for services.
Apart from bad-debt ratios, EBITDA per bed and overall utilization or capacity rates are other crucial metrics for investors to consider.
Other Industries
Pharmacy benefit managers (PBMs) are third-party companies that administer drug benefits on behalf of insurers. They work closely with health insurers and can be considered an outsourced segment of the health insurance industry.
When an individual goes to a pharmacy to fill a prescription, the pharmacy usually contacts the PBM to check if the individual is covered for that particular drug. PBMs also manage distribution centres that handle mail-order prescriptions.
PBMs tend to benefit from generic prescriptions and email transactions as they receive higher margins for these types of services. Moreover, PBMs with a large speciality pharmacy component tend to have higher margins because they receive higher margins on speciality drugs, such as biotech drugs or drugs that need to be refrigerated.
Distributors, on the other hand, serve as intermediaries between drug manufacturers and pharmacies and receive a service fee for handling the logistics for pharmaceutical companies. While some distributors offer additional services, such as drug packaging, their service-fee margin is the main driver of profits.
Medical technology and device companies manufacture a wide range of medical products, including artificial joints, heart stents, and bandages. These companies invest heavily in research and development, similar to drug manufacturers.
Investing in these companies requires an understanding of new technology as well as competitors and substitutes. Gross margins and adoption rates are important indicators of a company’s success, similar to other technology companies.
In the healthcare industry, hospitals and clinics are crucial providers of medical services. While all facilities with an emergency room must treat anyone who walks through the doors, regardless of their ability to pay, free-standing clinics and speciality hospitals that lack emergency rooms have emerged as competitors. Bad debts and cost controls are important metrics for evaluating hospitals’ profitability.
Hospitals that incorporate technological advances and recruit specialist physicians tend to perform better. EBITDA per bed and overall utilization or capacity rates are also key indicators.
