Invest in business, not predictive science

stands of Vinay Thapar, fund manager of AB International Healthcare Portfolio.Comment Sponsored Bernstein.

During market downturns, healthcare stocks often act as powerful painkillers. However, for investors who focus on business potential and resist the urge to predict scientific progress, the industry offers more than just a way to mitigate downside risk.

While the MSCI World Index fell 18.1% in 2022, healthcare stocks fell only 5.4%. However, The industry’s reputation as a safe haven underestimates its appeal. Pharmaceutical groups, medical device manufacturers and healthcare providers are benefiting from important trends that could boost returns for investors who can decipher the complex factors affecting the industry.

Three major trends

Three factors are currently spurring change in the healthcare industry: innovation, pricing structures and policy. However, This dynamic often conflicts with and complicates the investment prospects of a product or company.. Will people pay more for a revolutionary treatment if the health system doesn’t cover it? Is it possible for the government to decisively subsidize new diagnostic technologies? Are current prices sustainable in the long term? Such issues vary from country to country, depending on its government policies, national economy and spending, or cultural preferences.

Despite these difficulties, we believe there are ways to make informed judgments across the industry that can guide investors to reliable returns on investment and profitability. The first step is to avoid a common fallacy: not making predictions about drug trials. During the pandemic, many companies tried to develop vaccines against COVID-19, but only a few succeeded. Even the best scientists in the world cannot accurately predict the outcome of a trial.

, so why do investors take risks? Do the opposite: gain a clear understanding of how innovation, pricing, and policy dynamism affect a company’s profitability and growth rate.

Medical innovation

Scientific innovation has been supporting health advancements for decades. However, the technological revolution in healthcare is still in its early stages in many respects.investor They must look beyond cutting-edge equipment or biotech research to understand how innovation will reshape the industry. For example, although the use of big data and artificial intelligence in drug development remains relatively limited, over time they are likely to become indispensable tools for improving the effectiveness of drug trials.

New developments will have implications in many areas. Robotics are already changing surgery. Treatments for Alzheimer’s disease and cardiovascular disease will help address the physical and economic costs of demographic change. It is only a matter of time before solutions are developed to address age-related problems from the common cold to cancer.

price confusion

However, breakthrough innovations do not always make economic sense. Understanding how the price of a new product or service is determined is critical to measuring a company’s profit potential.

Innovation and pricing have a strange relationship in health. In the world of technology, it is known that innovation improves performance and reduces costs exponentially. The IBM mainframe computers that powered NASA’s Apollo spacecraft in the 1960s cost millions of dollars each and had a fraction of the memory and processing power of an iPhone. However, In health, the opposite is true: innovation tends to drive up prices. (Figure, left). For example, 25 years ago, cancer patients paid about $200 per month for chemotherapy, but the effect was limited; currently, some chemotherapy treatments can cure cancer with fewer side effects, but cost $100,000.

Price trends will determine winners and losers in healthcare

In many cases, investors must ask themselves whether the price is realistic. For example, Mylan’s EpiPen is a popular product that can prevent death in cases of extreme allergic reactions. Since Mylan acquired Merck & Co.’s generics unit, which includes EpiPen, in May 2007 (above, right), its price has increased more than sixfold. Is it sustainable? Although high-priced products can increase profits

and the company’s profit margin, They can also be obstacles If market dynamics or policy decisions force prices down.

Policy dynamics

Public policy in the health sector is a key factor in determining a company’s success or failure. Per capita health spending varies widely across countries. The quality offered does not always reflect the price paid. For example, the United States spends more on health than almost any other country in the world, but provides lower quality care than the United Kingdom and Germany, which spend much less (chart).

Policy dynamics are a key aspect for companies in the health sector

Policy decisions can mean the difference between life and death by determining what expenses are covered and how much treatment will cost. Healthcare systems around the world are feeling the burden of rising costs Workers are forced to face increased medical bills. At the same time, demand is growing in emerging economies and spending is likely to increase in efforts to improve the quality of health care. These trends will reshape pricing factors for treatments, technologies and services.

Business basics

With these three factors in mind, investors can evaluate companies in the healthcare industry. From our perspectives, A company associated with the innovative health sector, positioned for successLong-term investing amid price pressures and political quicksand Should have the following properties:

• Return on invested capital (ROIC) is high or increasing.
• High reinvestment rate.
• Strong balance sheet.
• A business with a lasting competitive advantage.

Be wary of companies that seek profitable growth at the expense of profitability. Very greedy companies should also be analyzed carefully, especially if they have accumulated large amounts of debt Or focus on selling a small set of products. Additionally, we believe companies whose future growth depends on the success of a single drug trial should be managed very carefully.

Intuitive Surgical is a great example of a company that scores highly on our criteria. The company is a leader in medical robotics; it has proven its technology in a field where competitors have high barriers to entry. Global adoption of robotic surgery continues to increase, with more than 1.5 million procedures set to be performed in 2021

, a 50% increase since 2018. Intuitive Surgical’s solid returns on invested capital provide the necessary financial means to expand and provide new opportunities in areas such as natural orifice surgery, which reduces the risk of surgeries and procedures. No scarring.

On the other hand, we believe pharmaceutical distributors and hospital centers tend to be questionable investments. For many drug distributors, the pricing model is unsustainable because companies charge based on shipment value., as opposed to the pricing model of other distribution companies, which base prices on size, weight and distance traveled. Hospital center profitability is also under pressure as new technological advances allow patients to avoid hospital visits for many treatments.

Effectively investing in healthcare stocks requires a unique set of abilities; these are not scientific notions. Adopting a rigorous investment process that integrates the various factors affecting health sector companies, Investors gain access to powerful sources of potential returns Can revitalize long-term equity portfolios.