Buying Opportunity: Healthcare Stocks P/E Hit 40-Year Low

One equity sector I wanted to do a brief focus on this week is the healthcare sector. The chart below shows the sector’s performance relative to the S&P 500 since mid-2019.

Data points above 100 indicate positive relative outperformance. As seen, in the early stages of the pandemic the group showed solid positive alpha. Since August of this year, the sector has been nearly inline with the broad index, but with a slight upward trending bias.

Now refer to the valuation chart below. Shown here is the price/earnings multiple based on FY2 (roughly calendar year 2021) earnings per share of the healthcare sector relative to the overall market price/earnings (P/E) ratio using the S&P 500.

The chart goes back 30 years, with a couple reference points shown: 

(1) the Clinton health plan and

(2) Obamacare. 

Given the fairly lengthy look back, I believe it gives a good broad historical view of the valuation of this sector relative to the broad equity universe.

The median value over this time span is a relative multiple of 1.07X, so the sector’s P/E has historically had a 7% premium to the overall S&P 500 P/E.

As seen, currently the healthcare P/E is at a very large 23% discount to the market P/E, easily at a 30-year low. In fact, though not shown here, if one looks at the data, it would be found that the sector’s P/E is actually at or near an astounding 40-year low on this relative P/E measure.

Valuation anomaly

Heightened policy uncertainty by investors — as all as concern that healthcare policy will be a major legislative focus after the incoming Biden administration takes office — I believe have truly created a meaningful valuation anomaly for this sector.

If history is any guide these large outlier valuation relationships typically get reverted back to the mean over time. If so, investors could do quite well by being invested in the healthcare space over the coming months and quarters.

Two excellent choices to invest in the overall healthcare sector via a passive ETF are the Vanguard Health Care Index Fund ETF (VHT) or iShares U.S. Healthcare ETF (IYH).

Gary has more than 30 years of industry experience, which includes research analysis and portfolio management for both retail and institutional accounts. He worked as a Senior Vice President at Wells Fargo Advisors and Wells Fargo Investment Institute for approximately 14 years in total, where he was a senior portfolio manager for both equity and asset allocation portfolios. He was also involved in investment manager due diligence and selection for the firm’s multi-manager portfolio models. Prior to joining Wells Fargo, Gary held senior-level investment management positions with several registered investment advisory organizations. He has been a Chartered Financial Analyst (CFA®) charter-holder since 1989. The CFA is a professional credential earned by investment management professionals after successfully passing three years of rigorous examinations and recording several years as a practising professional within the industry. Gary received his Bachelor of Science in Engineering from Purdue University and his M.B.A. in Finance from The University of Missouri. Additionally, Gary holds his FINRA SIE, Series 7 and Series 66 securities registrations as well as his Missouri Life Accident & Health insurance license. He is a member of the CFA Society of St. Louis and the Financial Executives Networking Group. He resides in Kirkwood, MO with his wife Kathy, and they have three adult age children, Aly, Ryan and Josh.