Everyone has experience with the health care industry. When you get sick, you buy medicine. If a sickness or injury is bad enough, you go to the doctor; if it is dire, you may call an ambulance to bring you to the hospital. All of these products and services live within the health care industry.
Because everyone has a need for quality health care products and services, the market is an absolutely massive one. According to Policy Advice, the global health care market could grow to be worth more than $10 trillion annually by the year 2022.
Any time a market is so massive, there’s plenty of room for big companies to make big profits and funnel those profits to investors. So, it’s not surprising to see that so many people want to invest in health care stocks.
But as great as investing in this industry can be, it can also be dangerous. Making the wrong investments in the space, known for wide swings in valuations, will lead to significant losses. So, it’s important that you understand the market and what makes it tick before risking your money in the space.
What Are Health Care Stocks?
Health care stocks represent a diverse group of health care companies. The health care category is an extremely broad one, encompassing a wide range of companies from multiple sectors.
All stocks within the biotechnology and pharmaceutical sector are included in the health care category. These companies create, manufacture, and market the medicines we take when we’re sick.
There are also plenty of stocks within the service sector that can also be categorized as part of the health care space. For example, health insurance companies, health care providers, and other companies that provide a medical service are included in the health care industry.
There are also several technology stocks that fall into the health care category. For example, the companies that create the technologies that make remote doctor’s appointments possible, like Teladoc, operate in the health care space just as much as they operate in the tech space.
Moreover, application and software companies that create health-related mobile phone apps, companies that store medical data in a HIPPA-compliant way, and companies that produce technologies like thermal imaging for use in medical applications are all in the health care category.
Even big tech is getting into health care, with companies like Apple, Amazon.com, and Alphabet all making sizable investments in the space.
Essentially, if the company sells a product or service that has anything to do with keeping people healthy, it’s a health care company. So, the health monitoring features on the Apple Watch make the company a health care company as much as Gilead Sciences’ treatment for hepatitis C makes it one.
Health Care Stocks Pros and Cons
There are plenty of benefits involved in investing in the sector, but there are pros to cons to everything — and health care stocks are no different.
Pros of Health Care Stocks
Investments in health care stocks come with several benefits. Some of the most important to consider when deciding whether to invest in the sector, include:
1. There’s a Wide Range of Opportunities
The health care market is massive, offering a wide range of opportunities across stocks with wide-ranging market caps that live at various different levels of risk. As a result, regardless of your goals when you make investments, you’ll likely find an opportunity or two that fits well in your portfolio.
For example, if you’re looking for a stable growth stock that pays dividends and comes with a relatively low level of risk, you would likely dive into a blue-chip stock like Johnson & Johnson. This stock has a long history of sustained growth and increasing dividends, fitting the bill for exactly what you want.
On the other hand, if you’re willing to take on more risk and want to get in on a company on the ground floor for a potential opportunity to win big in the long run, you may look at Novavax. This company has multiple vaccine candidates under development, some in late stages, and seems to be changing the way we see influenza vaccination while also working on a COVID-19 vaccine candidate.
If you’re somewhere in between and don’t want to take the risk on the ground level, but still want the opportunity for significant gains, you may look at a company like Gilead Sciences.
Gilead Sciences has seen great success with its hepatitis C treatment franchise. With work in COVID-19, HIV, and several other ailments, the company may see similar blockbuster success ahead. In the meantime, revenue and earnings growth generated from the early successes of the company greatly reduces the risk.
As you can see, no matter what your needs are as an investor, there’s a strong chance that a health care stock — or group of stocks — can assist you in meeting your investing goals.
2. The Industry Is Interesting
Successful investors will generally tell you they avoid investments in companies that do things they’re not interested in. There’s a good reason for that. To make money in the market, you have to be willing to do research into the companies that you’re buying pieces of.
If you’re interested in what you’re investing in, you’re more likely to do the research that’s required to make effective investments. Conversely, if you’re not interested in the product produced by a company, there’s a possibility that you will cut the research short, not getting the full story, and therefore, you’re incapable of making an educated investment decision.
The vast majority of children have an interest in science and what makes the human body tick. As you grow older, this interest tends to continue. It’s the reason both the “Bill Nye the Science Guy” and “MythBusters” TV shows were so popular, even though one was geared toward younger audiences and the other toward adults.
Health care and medicine are highly scientific topics. As a result, you’ll likely find the research into these topics more interesting than research surrounding topics like banking, commodities, or other industries that don’t have the “sexy” factor.
3. There’s a Feel-Good Effect
There’s no other way to say it. Investing in health care makes you feel good. When you invest in a health care stock, you’re investing in a company that has improving the lives of others at its core.
The entire sector is centered around making the sick feel better, improving the quality of lives of patients, and extending the length of life. Those are tall orders, and the heroes in the health care field fill those orders every single day. An investment in a health care stock can be as much a philanthropic move as it is a capital one.
In today’s day and age, socially responsible investing is becoming more popular. Investors are just as interested in the problems their investments address as they are in the money the investments can generate for them. The vast majority of health care investments lend a hand to the socially responsible investing trend.
Cons of Health Care Stocks
Although investing in companies in this space can be a lucrative venture and make you feel good in the process, there are also drawbacks to consider. Some of the most important drawbacks include:
1. Exclusivity Doesn’t Last Forever
In the health care sector — especially when it comes to companies that create new medicines and technology — exclusivity is important. When the U.S. Food and Drug Administration (FDA) approves a new drug, the regulatory agency grants an exclusivity period in which the company that receives the approval is the only one that can sell the treatment in the United States.
In general, this exclusivity period lasts for five years. However, for drugs that treat rare conditions or those that treat conditions with no other options on the market, exclusivity periods can be extended to up to seven years.
Once an exclusivity period expires, any other company can sell that therapy under a generic brand name, cutting a deep hole into the revenue generated by the original drug developer.
If a company does not continue to innovate and only has one approved treatment, the scars left by generic competition can be painful for the company and its investors, cutting into earnings growth and potentially leading to losses.
2. Clinical Trials Can Go Wrong
Many companies in the health care industry have an additional hoop to jump through. Before a drug, medical device, or therapeutic agent can make it to market, it needs to be tested in three phases of clinical trials.
Should any of these clinical trials go wrong for a company, its stock may experience a dramatic decline in value. This poses an added risk for investors considering buying companies in the clinical-development stage.
3. There Are Several Risky Plays That Look Good
There are quite a few companies in the health care category that sell a hope and a dream. The problem is that hopes and dreams are easy to buy into. For example, people understand the global health risks posed by AIDS and can get excited about the prospect of eradicating the disease.
Unfortunately, there is still no cure for the condition.
There are several companies out there working on a solution, and every company on the list will claim that they’re onto something big. However, the vast majority of life sciences and biotech companies looking for a solution to this problem are in early development stages.
When news is released that one of these treatments did well in mice, it’s easy to think that the treatment will do well in humans and make it to market. That’s not always the case. Moreover, the road to FDA approval can be a long and costly one, further adding to the risk.
The same can be said for companies creating medical devices or even pioneering new health care services.
As a result, it’s more important than ever for you to do your research to get a full understanding of the company you’re buying into prior to making an investment in health care.
When Should You Invest in Health Care Stocks?
Because there are a wide range of different types of investments available in the health care industry, any time may be a good time to invest in the space. The key here isn’t when to invest in general, but when to invest in which types of stocks in the sector.
Market Rallies and Economic Booms
When economic times are positive and markets are rallying, cyclical health care stocks are the stocks to buy. Cyclical stocks ebb and flow with economic conditions.
Cyclical stocks in the space often work in multiple sectors. For example, according to CNBC, Apple has spent years building internal medical teams. These teams have developed health care software, hardware, and — most recently — health care provider locations.
At the same time, Apple is known for some of the most successful technologies in the world. The company makes the iPhone, iPad, Apple Watch, and several other consumer electronics products, selling billions of dollars worth of its technology every year.
These products are decidedly cyclical. Consumers are more likely to spend thousands of dollars on technology when they are secure in their jobs and have a positive outlook of the U.S. economy. As a result, an investment in Apple, or another company like it, gives you exposure to the health care sector while allowing you to take advantage of positive economic trends.
Economic Declines and Market Crashes
If you are sick, you’re going to go to your health care provider, buy medicine, and do what you can to get well as quickly as possible, regardless of economic conditions. As a result, the vast majority of companies in the health care space are noncyclical investments.
These are the types of stocks you want to get involved in when economic conditions are declining. Getting out of the stocks that have a heavy correlation to the United States economy and getting into more stable-growth stocks like established health insurance, pharmaceutical, and health care service and technology stocks protects your portfolio from significant losses.
These stocks even have the potential to experience gains through economic downturns, making them safe-haven options worth considering.
How Much Should You Invest in Health Care Stocks?
Diversification is an important part of most successful investment portfolios. The idea is that, by investing in a wide range of asset classes, sectors, and stocks across the stock market, you have the ability to avoid significant losses on a single investment or a group of investments in a single sector or asset class.
So, how should you go about diversification when it comes to health care investments?
Consider Your Goals
The vast majority of established companies in the sector are stable-growth companies. Because their products are needed regardless of the time of year, economic conditions, or geopolitical situation, these are the perfect stocks for buy-and-hold investors.
On the other hand, if you’re looking for a strong income investment or a momentum play, the majority of established health care companies aren’t going to be best.
While some companies in the industry pay dividends, the average dividend yield in the industry is just 2.28% according to Dividend.com. That pales in comparison to the 3.2% average dividend yield in the technology sector, the 3.96% average dividend yield in utilities, or the whopping 4.92% average dividend yield in the basic-materials sector.
Also, while established health care companies are known for strong long-term growth, they are not known for momentous growth. Riskier, clinical-stage biotech companies may scratch this itch, but there are far less risky plays with which to take advantage of momentum.
Make Sure You Can Dedicate Enough Time
While the health care industry is generally an enjoyable and entertaining industry to research, there is a drawback. Health care is an incredibly convoluted space. There are quite a few working parts. Not to mention, the highly regulated nature of the health care sector adds a deeper level of research that’s required to understand long-term opportunities.
As a result, if you intend to invest in the health care space, it’s important that you have the time to do the research required to get a solid understanding of just what you’re investing in before you risk your money.
It’s also important to keep tabs on new innovation. Due to short-term exclusivity periods, health care companies — even established ones — must continue to innovate to drive growth in the future. Understanding a company’s product-development pipeline requires even more of a time commitment.
Managing a well-diversified portfolio full of health care stocks could be a full-time job. So, you’ll want to limit your health care allocation to the number of stocks that you have adequate time to research, both in performing initial due diligence and keeping tabs on continued innovation.
One way around the daunting research involved with investing in health care is to consider health care focused exchange-traded funds (ETFs), mutual funds, or potentially Nasdaq Composite Index funds because the Nasdaq is biotech- and tech-heavy.
Follow the 5% Rule
No matter what sector or asset class you’re interested in, the 5% rule is an important guideline to follow, especially for the beginner investor. The rule suggests that no more than 5% of your overall investment portfolio should be used for any single investment. You should also never spend more than 5% of your overall portfolio dollars on combined high-risk investments.
Following this rule, let’s say you are interested in Johnson & Johnson — an established name in health care that’s known for consistent growth — which you believe will continue to provide tremendous opportunity.
Say you have $10,000 in your investment portfolio. Based on the 5% rule, you can invest up to $500 in Johnson & Johnson. Because you believe the stock will continue to produce compelling growth, you decide to invest the entire $500 in the stock.
However, if you have some questions about the company’s ability to continue growing, you may invest $250 to gain exposure but limit risk.
Following the same example, let’s suppose you’re looking at five clinical-stage companies in the early stages of product development that you believe have real potential. Because these are all high-risk opportunities, the rule suggests you could invest $100 into each company, ensuring that the combined total value of these riskier investments would not exceed 5% of the overall value of your portfolio.
The health care industry is booming and filled with opportunities for investors. Not only do these stocks have the potential to generate gains within your portfolio, they have an added benefit: the feel-good effect of knowing that the company you’re funding is helping people live healthier lives.
On the other hand, not all stocks are created equal. When investing in the health care sector, be sure to do your due diligence and keep up with the companies you’ve made investments in. Short exclusivity periods and a highly regulated environment create added risks to consider.
Nonetheless, by doing your research, keeping tabs on your investments, and being a generally educated health care investor, the potential rewards are compelling.