Even the best scientists in the world cannot reliably forecast drug-test results, so why should investors gamble? Quality businesses are key for healthcare stocks.
Healthcare stocks often serve as powerful painkillers during market declines. Yet the sector offers much more than just downside mitigation for investors who focus on business potential and resist the urge to predict scientific breakthroughs.
While the MSCI World Index fell by 18.1% in 2022, healthcare stocks fell by only 5.4%. But healthcare’s reputation as a defensive haven understates the sector’s attractions. Pharmaceutical groups, medical device manufacturers and healthcare providers are benefiting from big trends that can help fuel long-term returns for investors who are skilled at deciphering the complex forces shaping the sector.
Three Big Trends
Three forces are stimulating change in healthcare today: innovation, pricing structures and policy. However, these dynamics often clash and complicate the investment outlook for a product or company. Will people pay more for a revolutionary treatment if it isn’t covered by a healthcare system? Is a government likely to provide meaningful subsidies for a new diagnostic technology? Are current prices sustainable over the long term? Questions like these vary from country to country, based on government policies, national economics, and spending or cultural preferences.
Despite these challenges, we believe there are ways to make informed judgments across the industry that can lead investors to solid sources of profitability and investment returns. The first step is to avoid the common fallacy that drug trials can be predicted. During the pandemic, many companies tried to develop COVID-19 vaccines, but only a few succeeded. Even the best scientists in the world cannot reliably forecast drug-test results, so why should investors gamble? Instead, develop a clear picture of how innovation, pricing and policy dynamics could affect a company’s profitability and growth rate.
Medical Innovation
Scientific innovation has underpinned healthcare advances for decades. Yet in many ways, the technological revolution in healthcare is still in its infancy. Investors need to look beyond cutting-edge equipment or biotechnology research to understand how innovation will reshape the industry. For example, although the use of big data and artificial intelligence is still relatively limited in pharmaceutical development, over time they will probably become integral tools in improving the efficacy of drug trials.
New developments will make an impact across many areas. Robotics are already changing surgical procedures. Treatments for Alzheimer’s disease and cardiovascular disorders will help combat the physical and economic costs of demographic change. The development of solutions to age-old problems from the common cold to cancer is just a matter of time.
Pricing Disruption
Still, powerful innovations don’t always make economic sense. Understanding how pricing points are determined for a new product or service is essential to gauge a company’s earnings potential.
Innovation and pricing have a curious relationship in healthcare. In technology, it’s well known that innovation drives performance improvements and pushes down costs exponentially. The mainframe computers that powered NASA’s Apollo spacecraft in the 1960s and cost millions of dollars each had a fraction of the memory and processing capacity of an iPhone. But in healthcare, the opposite happens: innovation tends to drive prices up (Display, left). For example, 25 years ago, cancer patients paid about $200 a month for chemotherapy, and success was limited. Today, some chemotherapy treatments can cure cancer with fewer side effects, but at a cost of $100,000.
