Pharmaceutical companies are often in the healthcare spotlight. From COVID vaccines to weight loss pills, breakthrough pharmaceuticals aim to cure humanity’s ills and improve quality of life. Investors are often excited by the potential of a blockbuster drug that aims to eradicate an incurable disease – and make them a tidy profit.
Because large pharmaceutical companies are healthcare heavyweights, they often dominate sector positions in a global equity portfolio or stand-alone allocation. However, too much focus on the pharmaceutical industry could limit a portfolio’s potential. Companies that produce diagnostics, technologies and devices to solve the world’s most pressing medical problems have become increasingly important to advances in the healthcare sector.
The changes in healthcare stock indexes over the past two decades reflect this shift. The weighting of pharmaceutical companies in the MSCI World Health Care Index has fallen from 82% in 2000 to 43% today (illustration).
Diagnostics and life science instruments and services – These areas are as important to medical processes as the treatment itself. State-of-the-art tests and imaging techniques can help doctors detect diseases at a much earlier stage, improving the effectiveness of treatment and the chances of recovery. And sequencing the human genome will yield other potential new drugs and help detect diseases earlier.
Waters Corporation manufactures analytical instruments for scientific research in drug development and manufacturing processes. In the highly regulated pharmaceutical industry, the company’s strong reputation has maintained customer loyalty and generated recurring revenue streams that strengthen its competitive advantages. The USA is also home to IDEXX Laboratories, which specializes in animal diagnostics such as: B. precise, in-house laboratory equipment that provides veterinarians with results within 10 minutes.
In biotechnological research and development, innovative drug development processes enable new treatments that can be profitable even for relatively rare diseases. United Therapeutics, for example, makes a drug to treat a relatively rare condition called pulmonary arterial hypertension – high blood pressure in the pulmonary artery. The company has also reinvested in its organ transplant business and is trying to use genome editing technology to increase acceptance of organ transplants of animal origin, which are often rejected by the human body.
Technology and Artificial Intelligence (AI) – Compared to other sectors, healthcare has been a technological laggard. But that is changing now. Companies that successfully adopt new technologies can dramatically change the way care is offered and delivered – and they can be found in different areas of the sector.
Artificial intelligence is used in commercial applications by companies such as Veeva Systems from the USA and the Irish company ICON. As AI capabilities improve and are used more widely to diagnose diseases, we believe companies offering software as a service to healthcare will see greater demand. GE HealthCare, a medical device company, is using AI in various products, such as improving the quality and diagnostic ability of medical imaging devices, which can lead to better patient outcomes.
Equipment and accessories — From global drug manufacturers to your primary care doctor, the devices and applications used to deliver healthcare products and services are constantly changing. Innovative devices used in life-saving procedures can improve patient outcomes.
A rapid technological revolution is currently taking place for surgeons. Today’s surgery increasingly uses robots, allowing surgeons to reach hard-to-reach places in the body with high-precision, minimally invasive incisions, resulting in fewer complications and faster recovery times. The US company Intuitive Surgical produces a robotic surgery system that is widely used in US operating rooms and is also gaining popularity outside the US. We believe there are significant growth opportunities in Europe, Japan and China.
Three attributes define healthy growth
Although every industry has different dynamics, we believe investors should look at three attributes to identify attractive healthcare companies across the sector (illustration).
First, they should look for products and services that improve healthcare outcomes for patients. Second, companies that can help cash-strapped health systems save costs are likely to benefit from strong demand. Third, products that improve outcomes and save costs must generate a profit for the company.
In our view, companies that exhibit these three characteristics operate in a favorable environment. This provides the foundation for companies to profitably reinvest cash flows, contributing to consistent profit growth over time. We believe that when selecting healthcare stocks, equity investors should always focus on the business fundamentals rather than trying to predict scientific success, which is extremely difficult.
Certainly, pharmaceutical companies that meet the criteria of a healthy environment should be included in a diversified allocation of healthcare stocks. But rather than viewing drugmakers as the anchor of a healthcare portfolio, the starting point should be to look for high-quality business models – wherever they may be found in the evolving spectrum of medical products and services.
By Vinay Thapar, Portfolio Manager – Global Healthcare at AllianceBernstein
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