SEARCHING FOR VALUE IN THE HEALTHCARE SECTOR

“You don’t make money when you sell; you make money when you buy.”

This old adage means that, if you buy assets for the right price, it’s hard to not make money in the long run. However, most analysts agree that today’s stock market is very richly valued, if not grossly overvalued altogether, so buying smart is not easy at the moment. But our new Equity Analyst Grant Bailey went looking for good deals in the healthcare space, and he did manage to find some attractive propositions. If you carefully parse the numbers, you can always find some deals that others forgot. And here, one name stands out….

Research & Analysis by Grant Bailey, Equity Analyst

There are several intriguing dividend-paying healthcare stocks available on the market, but not all stocks were created equal. There’s much more to each of these companies than meets the eye. Unfortunately, analysts’ stock forecasts don’t exactly solve that issue. So, how can we solve it? We find the numbers, then we apply the numbers; if you’re looking for safer and steadier gains, value stocks are the way to go.

We can identify this value by running a methodical screening and evaluation process based on publicly available data.  

So, that said, where can we find the best value? The numbers would say it’s between these four: Medtronic (MDT), Sanofi (SNY), Quest Diagnostics (DGX), and Fresenius Medical Care (FSNUY). What makes these options attractive? Is there a standout between these 4? Perhaps more importantly, which stocks should make their way into your portfolio?

Medtronic (MDT)

We begin our journey here with Medtronic, headquartered in Dublin, Ireland. While the stock has a somewhat modest P/E ratio of 25.65, suggesting the stock is level to its fair value, there is far more data involved. For starters, MDT has a P/B ratio of 2.21, which compares its market value to its book value. This metric compares the theoretical value of a company’s assets to the actual price that the stock market currently assigns to those assets. Generally speaking, value investors typically look for stocks with a P/B ratio below 3.0. 

MDT also has a P/FCF ratio of around 20, which suggests that they’re doing business fairly well; for context, P/FCF compares a company’s market value to its free cash flow, and a P/FCF between 15 and 20 suggests that the company is fairly valued. Additionally, MDT has an exceptional current ratio of 1.84 and a quick ratio of 1.39, which suggests that Medtronic can easily pay off its short-term obligations. Normally, a current ratio between 1.0 and 2.0 and a quick ratio of over 1.0 is optimal. Furthermore, with a debt-to-equity ratio of 0.51, MDT appears to have sound financial leverage as it can easily pay off its long-term debt, indicating strengthened stability.  By all of these metrics, the company is selling for a fair price and investors know they can sleep well at night by owning a business that is on rock solid financial footing. 

The issues? Their P/S ratio of 3.34 is fairly concerning. The P/S ratio compares a stock’s price to its revenue, and a P/S ratio under 1.5 is ideal. Another issue is their payout ratio of 84.54% which suggests that their current dividend yield is highly unsustainable. This ratio means that the company is currently paying out almost 85% of their annual profits in the form of a dividend. With a ratio this high, it may be hard for Medtronic to keep raising the dividend in the near to midterm future. 

MDT’s stock has been dropping over the past few years, which is due to consistent earnings misses. While MDT holds a Zacks Value score of B, they also have a Zacks VGM (value, growth, and momentum) score of D, which suggests that Medtronic has extremely unattractive growth and momentum scores. However, considering optimistic stock forecasts predicting 12-month growth of over 10%, along with several promising valuation metrics, this stock is a buy, right? I’d argue that Medtronic should actually underperform the broader market; the stock seems to be trading below its “fair value” for a reason! The growth prospects for the company’s medical devices seem lackluster for the foreseeable future. Although its very likely that Medtronic will continue to exist for years to come, there is nothing about their current innovation pipeline that is exciting investors. 

Sanofi (SNY)

Moving on to Sanofi, headquartered in France, the analysts seem to love this one! With the average price target representing nearly a 25% increase from their current price, stock forecasts are looking very favorable. Sanofi has an average P/E ratio of 24.79, but other metrics tend to lean more towards their advantage. For one, their P/S ratio of 2.29, while not quite preferable, is still less concerning than MDT’s P/S ratio. Sanofi has a P/B ratio of just 1.56 and a current ratio of 1.0 as well. While Sanofi does have a quick ratio under 1.0, it shouldn’t be much of an issue as they have an exceptional operating margin of over 16%, which indicates that SNY generates profit very efficiently through its core operations. Another important notion is that Sanofi has a debt-to-equity ratio of just 0.17, which is very optimal. Down 17% from their high in early September after some weak drug test results in phase 3 of Rocatinlimab and Uplizna, the damage should be about finished. 

Possibly the biggest issue is Sanofi’s payout ratio, which stands at 104.79%. This means that the company is currently paying out more that their annual profits in the form of dividend. This renders Sanofi’s dividend of 4.20% completely unsustainable: a drop in its dividend yield should most certainly be expected. However, a dividend yield of about 2% should still be sustainable for Sanofi, which isn’t much less than the Healthcare sector dividend average of 2.28%. Sanofi currently has a Zacks Value score of A, but a Zacks VGM score of C. The company currently has 27 agents in phase III studies, but many of those are new indications for medicines that are already on the market. The phase III pipeline is probably enough to provide slow but steady growth, but there is no one obvious blockbuster new drug waiting in the wings. 

I’d initiate an outperform rating on SNY. Would I expect the 25% increase that analysts have predicted, on average? Probably not.

Quest Diagnostics (DGX)

Next on the list is Quest Diagnostics, based in Secaucus, New Jersey. Quest Diagnostics stock forecasts are a bit lackluster, to be quite frank. With the average price target representing a 12-month gain of 8%, analysts seem to view DGX as a very mediocre stock. DGX has a low P/E ratio of 21.31, a respectable P/S ratio of 1.87, and a moderate P/B ratio of 2.60. Along with these promising metrics, DGX also has a healthy P/FCF ratio of 17.45, a favorable current ratio of 1.25, an ideal quick ratio set at 1.17, and a very efficient operating margin of over 13%. If that’s not enough to indicate safety and security, Quest Diagnostics also maintains a payout ratio of 38.88%, which suggests that its current dividend yield is sustainable and quit likely to keep growing for the foreseeable future. 

DGX doesn’t really have many blatant red flags, but one metric to be aware of is its debt-to-equity ratio, which has recently spiked to 0.83. This number is not ideal, but it’s also not completely terrible. DGX’s debt-to-equity ratio was just 0.57 the previous quarter and the last time it was as high as 0.83 was in 2016, so they haven’t typically allowed their debt to get too out-of-hand. Considering this, I don’t believe that Quest Diagnostics’ debt-to-equity ratio should be too much of a concern. With a Zacks Value score of B and a Zacks VGM score of C, most would probably not be too excited about DGX. However, I’d go against the grain a bit on this one; I’d expect them to outperform their 8% expected gain.  Quest Diagnostics is a low margin, high volume business with a dominant market position. This means the earnings and dividends will continue to grow along with the general need for medicine in the USA. With 10,000 Baby Boomers per day getting Medicare cards, that will mean a lot of blood tests. However, the company’s modest valuation reflects a “slow but steady” growth plan. 

Fresenius Medical Care (FSNUY)

The fourth and final stock on the list is Fresenius. The healthcare company based in Bad Homburg, Germany appears to be a very intriguing option. With overwhelmingly bearish stock forecasts representing a decline of nearly 12% from the current share price, this stock seems to be quite unpopular among analysts. However, their value metrics could suggest optimism. With a bargain basement P/E ratio under 20, an exceptionally cheap P/S ratio of just 0.68, an impressive P/B ratio of 0.87, and a well above-average P/FCF ratio of 8.24. Moreover, they have a near-perfect 1.37 current ratio, a solid quick ratio of 1.02, and an optimal debt-to-equity ratio of 0.42. If further convincing is needed, it can absolutely be provided; FSNUY has a payout ratio of just 26.23%, indicating that there is much room for growth regarding their current dividend of 2.67%. The only potential concern here is Fresenius’s operating margin, which currently stands at roughly 8%. However, considering Fresenius’s current financial situation, I do not believe this should be cause for concern. FSNUY stock holds a Zacks Value score of A and also a Zacks VGM score of A. Contrary to analyst forecasts, I expect FSNUY stock to not only increase but also outperform the broader market over the next 12 months. 

As Warren Buffet famously quipped “Price is what you pay; value is what you get.”  And there is a lot of value here. Fresenius is one of the largest private hospital operators in Europe; they also sell a variety of medical supplies and services in dozens of countries around the globe. As Europeans get older and older, it would be hard for Fresenius to not make money; demand for their services is virtually guaranteed. So, why are the shares so darn cheap? 

The answer is that Europe, in general, is totally out of favor with global investors. America is seen as a shining beacon of innovation, technology and entrepreneurship, so many less diligent investors have given up looking for value in Europe. While Fresenius will never be as sexy as Nvidia or Palantir, the large, entrenched company sells something of critical value to an ever growing market: a Europe that is increasing filled with old people. 

All-in-all, the standout among these four should be clear as day; Fresenius seems to not only be trading well below their intrinsic value but also possesses promising growth potential and great momentum. As for the safest investment between these four, either FSNUY or DGX would appear to be about as safe and secure as you can get. Medtronic and Sanofi may have much higher stock forecasts, but when you take a deeper look into what is actually being analyzed, it becomes clear that Fresenius Medical Care and Quest Diagnostics should likely show better growth than either MDT or SNY.