Healthcare: HMOs & Hospitals

The healthcare sector is not homogeneous and includes many different industries ranging from managed care organizations, healthcare facilities providers, medical device manufacturers to biotech and pharmaceutical companies. Investors in heathcare therefore should remain mindful of the different drivers and appropriate metrics associated with the various sub-sectors.

That said, and recent market volatility aside, long-term growth of the healthcare sector overall continues to be fuelled by aging of the population and decisions in Congress related to government funding. Given the ongoing reform debate in Congress, healthcare policy changes remain an important signpost to investing in the sector.

As would be expected in the current backdrop of potentially unfavorable regulatory change, the outlook for many health care industry groups is currently in the ‘Bad’ category. As case in point is the Managed Care Industry (HMOs), whose fortunes are set to be negatively affected by most of the legislative proposals currently on the table for healthcare overhaul.

While there certainly can be good stocks in industries with bad outlooks, our general preference is to avoid such industries altogether. Not every healthcare industry group will be affected equally by the potential changes around the corner, which provides for plenty of investment opportunities in the healthcare space.

Opportunities

The already favorable earnings outlook for hospital administrators received a further boost from a recent rule change by the Center for Medicare and Medicaid Services allowing increased rates. Driven by positive earnings revisions, the hospital industry has an attractive Zacks Industry Rank 18, putting it towards the top of the 217 industry groups in our universe.

Particularly well positioned in this space is Universal Health Services ([url=http://www.zacks.com/stock/quote/uhs]UHS[/url]), the fifth largest for-profit healthcare facilities company in the U.S. This company is also the largest public operator of behavioral facilities in the country. This Zacks Rank # 1 company reported better than expected second quarter results this week, with a 36% year-over-year growth in earnings.

Another company well positioned in this space is MEDNAX ([url=http://www.zacks.com/stock/quote/md]MD[/url]), a leading provider of neonatal, maternal-fetal and pediatric physician services. The company not only produced better-than-expected quarterly results recently, but also provided a favorable outlook.

Weaknesses

We remain wary of the HMO players given the regulatory/public policy headwinds. Our research shows that even excellent stocks in a bad industry underperform, as they get pulled down by their peers. A case in point is Amerigroup Corporation ([url=http://www.zacks.com/stock/quote/agp]AGP[/url]), which through its substantial Medicaid-related business remains heavily exposed to budgetary pressures at the state level.