The Worst Appears Over for Health Companies

Investors, according to the conventional wisdom, hate uncertainty.

So now that the details of President Clinton’s health care plan are known, will this relieve some of the pressure on beleaguered health care and biotechnology stocks--and the mutual funds that invest in them?

Some professional investors think so.

“This will mark the bottom for health care stocks,” predicts Mike Yellen, an analyst for the Franklin Global Health Care Fund in San Mateo, Calif.

“From here on, I expect to see one compromise after another until a consensus eventually forms around some of the more moderate proposals,” such as insurance reform, he says.

The fact that health stocks rallied the day following the Clinton speech shows that investors realize the challenge facing the health care industry isn’t as bleak as first thought, says Jack Bowers, editor of the Fidelity Monitor newsletter in Rocklin, Calif.

“Stocks often rally when the bad news isn’t as bad as people expect,” says Bowers, who is considering changing his view of the health care funds from a “hold” to a “buy.”

Though certain health care stocks won’t fare as well as others, the overall mood should be more favorable, many believe.

It couldn’t get much worse.

After a tremendous run from 1989 through 1991, health care stocks and the funds that own them have been hit hard lately. The 16 pure health-biotechnology funds had tumbled about 16% from January, 1992, through mid-September of this year, reports Lipper Analytical Services of Summit, N.J.

Over the past half year, combined assets of the funds have shrunk to $4.2 billion from $5.4 billion.

The worst performance stretch for most of the funds came during the first quarter of 1993, when Clinton set his agenda.

The fate of Clinton’s reforms are also of interest to investors in more widely diversified stock funds, many of which have amassed significant stakes in the health sector.

Growth-and-income stock funds on average have about 9% of their assets in the health area, according to Morningstar Inc. of Chicago. Small-company funds have closer to 12%.

Health stocks, especially the large pharmaceutical firms, have long been considered classic growth companies because of their ability to keep churning out higher profits.

But after many months of sagging share prices, the companies are looking more like value stocks and have attracted some bargain hunters.

In fact, pharmaceutical stocks now trade at an average price-earnings ratio below that of the Standard & Poor’s 500 index.

The relative P/E valuation of the drug stocks is at its lowest level in more than 20 years, says L. Roy Papp, manager of a Phoenix-based stock fund that bears his name. In 1974, the drug companies were trading at an average multiple three times that of the S&P; 500.

Just about everyone agrees that it will take at least several months for Congress to scrutinize and debate the Clinton proposal, with the possibility that some health care stocks could be volatile.

“We have just seen the beginning of what will probably be one of the most intensely lobbied bills in history,” says James Gipson, manager of the value-oriented Clipper Fund, based in Beverly Hills.

But uncertainty also creates opportunity, which explains why Clipper now has 16% of its assets in pharmaceutical stocks, up from zero at the start of the year.

By contrast, pharmaceutical stocks have dropped slightly to an 8% weighting in Papp’s fund, a growth-oriented portfolio.

“What we like are companies with highly predictable earnings, which doesn’t describe the drug stocks right now,” he says.

In Yellen’s view, health maintenance organizations and manufacturers of low-cost generic drugs are among the best bets for growth in the health care field.

“What they have in common is that they’re plays on the cost-containment theme,” he says.

Franklin Global Health Care is overweighted in those two areas and underexposed to large pharmaceutical stocks.

The same goes for the small-stock PBHG Growth Fund in Wayne, Pa., which has about 20% of its assets in the health care field.

The fund’s holdings include health maintenance organizations, a nursing home operator and an information systems company that helps hospitals operate more efficiently.

The fund has little in the way of large pharmaceutical companies or hospital chains.

“Our investments tend to be specialty, low-cost health care providers,” says Gary L. Pilgrim, the fund’s portfolio manager.

“We’re not making a contrarian bet on health care, just ferreting out companies that are doing well and meeting our earnings expectations.”

Health Care Funds: Feeling Blue The threat of cost controls and other reforms in the medical industry has contributed to a selloff of health care and biotechnology stocks. Over the past two years, the mutual funds that concentrate on these stocks have gone from first to last place in average performance among all stock fund categories. This chart shows average total returns for these portfolios and for stock funds overall. 1988 Health/Biotechnology Funds +11.1 All Stock Funds Average +13.6 1989 Health/Biotechnology Funds +43.5 % All Stock Funds Average +23.8% 1990 Health/Biotechnology Funds +19.4 % All Stock Funds Average - 7.3% 1991 Health/Biotechnology Funds +74.3 % All Stock Funds Average +30.7 % 1992 Health/Biotechnology Funds -8.3 % All Stock Funds Average +6.0 % 1993 Health/Biotechnology Funds -8.3 % All Stock Funds Average +12.2 % Source: Lipper Analytical Services Summit, N.J.