Best bet in health care? Biotech

This ETF provides a diversified way to invest across the sector.

By TheStockAdvisors Feb 21, 2013 4:47PM
By Mark Salzinger, The Investor's ETF Report

Every healthcare ETF we track — all 14 of them — generated double-digit returns in 2012. And so far, in 2013, each has outperformed the S&P 500. Our favorite ‘growth’ segment within the healthcare sector remains biotechnology stocks.

We have included iShares Nasdaq Biotechnology (IBB) in our Master Wealth Builder portfolio for several years, over which time it has been a top performer. The ETF lost only 12.3% in 2008’s market upheaval (vs. 37.0% for the S&P 500), and has gained 13.6% on an annualized basis over the past five years (vs. 4.0% for the index).

Select biotechnology stocks have outstanding growth profiles, and those with approved and commercialized treatments are often highly profitable.

That’s because biotech companies, whose products are built mainly from proteins rather than chemicals, generally are focused on therapeutic treatments for chronic, life-threatening conditions for which few competing treatments exist.

For example, six of the 10 highest selling biotechnology treatments in 2012 were for cancer or cancer-related ailments.

Eight of the 10 highest selling pharmaceutical (i.e., chemical) treatments were for serious but potentially less lethal conditions such as gastrointestinal disorders, depression and high cholesterol, which face are many competing treatments.

This means that health insurance, including Medicare, is more likely to pay higher prices for biotechnology treatments than for many of the new treatments being developed and launched by the pharmaceutical companies.

As such, biotechnology stocks are attractive acquisition targets for both ‘big pharma’ and, increasingly, larger biotech companies like Amgen.

That’s part of the reason we like IBB, since small- and micro-cap stocks account for about one quarter of the assets in the 120-stock portfolio. The diversification also reduces stock-specific risk and provides considerable exposure to potential treatments.

IBB does sport a premium valuation though, owing largely to its 33.2% gain in 2012 and further 6.1% gain in January 2013. Its average price/earnings (P/E) ratio on 2013 estimated earnings was recently 18.3, vs. 13.3 for the S&P 500.

When compared to IBB’s potential growth however, its current valuation seems more modest. Long-term earnings growth expectations for IBB’s portfolio were recently 18.2%, giving the portfolio a P/E-to-growth (PEG) ratio of roughly 1.0, which is much more attractive than the 1.5 PEG for broad-based health care ETFs.

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