Should You Invest in Healthcare Stocks?

We typically know that investing in our own health can often provide solid wellness returns. But what about investing in healthcare stocks? Can putting your money in the healthcare sector offer hearty portfolio gains?

"Everybody needs healthcare or will at some point," says Robert Banks, founder of MrStocks.org. "And when there's something everyone needs, that means a huge opportunity for investors and a good time to invest."

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The healthcare sector is growing faster than the overall global economy, Banks adds. And healthcare stocks will likely continue to grow throughout the next decade. But that doesn't mean you should place all your cash into just one potentially blossoming industry.

"Broad diversification across several industries is a critical risk-mitigating strategy for investors," says Matthew S. Eads, CFA, at Eads & Heald Wealth Management. "Investing in a diversified portfolio allows one to participate in market upside but also mitigates downside risk if one or a few industries are doing relatively poorly."

Ashtyn Evans, CFA, a healthcare analyst at Edward Jones, recommends that healthcare stocks make up 15% of your equity portfolio. "As a defensive sector," she says, "healthcare has traditionally performed better than the broader market in times of heightened uncertainty."

Outlook of healthcare stocks and other considerations

Healthcare stocks may have caught your eye over the past year, especially with the COVID-19 pandemic. Earnings for healthcare companies have held up relatively well over the course of the crisis, Evans points out. "This is because healthcare spending is more difficult to defer," she explains.

Evans expresses an overall favorable view of healthcare stocks for the long term. But risks still exist, she cautions. One consideration is that rising healthcare costs appear unsustainable, so that could shift the industry down the road. But recent changes have caught people's attention.

"The transformation of the sector over the past several years also makes it more attractive than in years past," adds Lindsey Bell, chief markets and money strategist for Ally. "There are more tech-oriented companies as well as biotechs than before. The stodgy pharma companies no longer overpower the industry."

External demand is a driving force of the rapidly changing landscape. "As payers, politicians, and patients increase their calls for high-quality care at lower costs," Evans explains, "and with the looming threat of disruption by outside forces such as Amazon, healthcare companies are being pressured to demonstrate their value with new products—often involving the use of technology—that help lower healthcare costs."

Companies that respond well to external demands may offer some good investment opportunities. "We believe companies that are diversified by product and geography and that have exposure to innovation will be rewarded over time," Evans says.

Bell agrees. "Look for companies that have strong cash flows, reasonable valuations, and have the potential for future growth," she adds.

Types of healthcare stocks

Healthcare stocks fall into five general types: drugs/therapeutics, medical devices, payers, providers, and telehealth. But some will fit multiple categories.

Drug stocks are pharmaceutical companies that research, develop, and make medications, also called therapeutics, to treat conditions and diseases. Drug stocks are one of the most important types of healthcare stocks, according to Banks. Pfizer (NYSE:PFE) and Merck (NYSE:MRK) are some examples of drug stocks.

Medical device stocks are exactly what they sound like: companies that make medical devices, Banks explains. Dexcom (NASDQ:DXCM), for example, makes continuous glucose monitoring systems for people with diabetes. And Stryker (NSE:SYK) makes surgical equipment and other devices.

Payer stocks involve a mix of health insurance providers and pharmacy benefits managers (PBMs), Banks says. PBMs manage prescription drug benefits for health insurance plans and large employers. Many payer stocks will include both a health insurance segment and PBM segment. Anthem (NYSE:ANTM) is a health insurer that also operates the PBM IngenioRx, for example. And CVS Health (NYSE:CVS), which owns the insurance provider Aetna, also includes CVS Caremark, one of the three largest PBMs in the U.S.

Provider stocks are companies that deliver healthcare to patients, Banks explains. HCA Healthcare (NYSE:HCA) is a for-profit hospital system, for example.

Telehealth stocks are companies that help patients access healthcare remotely. And this category has emerged as an exciting new frontier when it comes to healthcare stocks, says Asher Rogovy, chief investment officer at Magnifina. "By making access to healthcare much more convenient," he explains, "patients are more likely to utilize it. This means increased revenue for telehealth providers." Teledoc (NYSE:TDOC) is one of the best-known telehealth stocks, he adds.

How to decide on healthcare stocks

When it comes to investing, each person is different regarding their financial situation. You should consider your risk tolerance as well as other factors. That's why Eads says there's no one-size-fits-all recommendation for investing in healthcare stocks.

But he does offer a few tips for finding the right fit. Look for healthcare companies that are leaders in their industry and have a history of producing not only quality products but widely adopted ones. Also check for a performance of steady earnings growth.

"If one is looking at pharmaceutical stocks," he says as an example, "look for companies with a long, successful track record of bringing effective treatments to market along with a healthy pipeline of drugs in development."

Overall, the rule of thumb is to find ways to spread the proverbial eggs across several baskets. "If an investor is intent on investing in healthcare stocks in the absence of working with a professional investment manager," Eads says, "it would be wise to look at low-cost healthcare mutual funds or healthcare ETFs. These solutions provide instant diversification of many healthcare stocks."