A Roadmap for Effective Healthcare Investing:
Navigating the Minefield

Benefit #2.  Preservation of the Vast Majority of Healthcare’s Investible Market Capitalization:  Of healthcare’s approximately $5 trillion of investible market capitalization, the roughly 200 profitable companies account for $4.5 trillion, or 90% of the total capitalization. The remaining 600 unprofitable companies account for the remaining $500 billion, or 10%.  As the sector continues to grow, the $4.5 trillion of profitable company market capitalization should likewise continue to grow.

Benefit #3.  Diversification across Healthcare Sub-Sectors:  A further analysis of the profitable subset of companies reveals that they are spread fairly evenly across the therapeutics, devices, and services sub-sectors.  In contrast, the vast majority of unprofitable companies are components of the therapeutics sub-sector, particularly biotech.

 

Benefit #4.  Diversification by Market Capitalization:  A further analysis of the profitable subset of companies reveals that their market capitalizations are spread fairly evenly across large-, mid- and small-caps.  In comparison, the vast majority of unprofitable companies have market capitalizations below $1 billion.

 

Benefit #5.  Scalability and Liquidity Implications:  Because the 200 profitable companies account for $4.5 trillion of market capitalization and include many mid- and large-cap companies with deep underlying liquidity, an investment strategy focused on constructing a portfolio of such companies has multi-billion dollar scalability with ample liquidity.  In comparison, a portfolio of unprofitable companies can often have capacity constraints and significant illiquidity risks, which become exacerbated as assets in those strategies scale.

 

Benefit #6.  Qualitative and Quantitative Risks:  Importantly for risk-conscious investors, the key considerations and variables impacting investment performance can be vastly different for profitable, commercial-stage companies compared to unprofitable, often development-stage companies.  Most notably, the due diligence process for many unprofitable companies is centered around predicting the outcome of unknowable binary events, which are often many years and tens or hundreds of millions of dollars from becoming knowable. Beyond qualitative risks, portfolios of profitable companies tend to be quantitatively lower risk than portfolios of unprofitable companies across multiple metrics.

 

Benefit #7.  Compelling Corporate Missions and Value Propositions:  From the universe of profitable companies, one can find fundamentally sound companies with strategic priorities and core competencies that dovetail with key trends propelling the dynamic healthcare sector forward.  Examples of such trends include:

• the foundational shift from a volume-based to value-based system; 

• the increasing number of healthcare services being provided in lower-cost, higher-quality outpatient settings; 

• the burgeoning influence of the healthcare consumer and associated demands for, amongst other things, more choices and transparency; 

• the pervasiveness of technology and interoperability; 

• the growth in government-sponsored healthcare via Medicare and Medicaid; and 

• the import of operating scale and purchasing power across sub-sectors.

 

Benefit #8.  Large Market Opportunity:  The addressable market opportunity for certain profitable companies is in the hundreds of billions of dollars.  For example, managed care plans for Medicare beneficiaries (principally Americans age 65 and older), commonly referred to as Medicare Advantage plans, continue to provide value to the Federal government and consumers.  Beyond Medicare, Medicaid (covering low income, disabled and other vulnerable populations) is now a “third rail” in national politics.  This reality, coupled with states’ continued focus on reducing their “fee-for-service” Medicaid outlays, provide Medicaid Managed Care companies with a significant and growing opportunity.  Together, Medicare Advantage and Medicaid Managed Care represent a market opportunity totaling in excess of $500 billion.

 

Benefit #9.  Utilization of Tried-and-True Valuation Multiples:  Profitable companies, unlike unprofitable companies, have valuation multiples that are measurable, meaningful, and can serve as an adjunct throughout an investment process.  One key determinant in the realization of investment gains versus losses is the price paid at the investment’s inception. Effectively incorporating tried-and-true valuation multiples into an investment process can facilitate finding attractively-valued companies and entering investments potentially closer to trough, rather than peak, valuations.

 

Benefit #10.  Differentiation:  An investment portfolio comprised exclusively of profitable, publicly-traded healthcare companies is different from most healthcare-focused investment portfolios.  In investing, doing something different in a methodical, repeatable, and scalable manner is often a key ingredient in constructing long-term, uncorrelated outperformance.

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Other Critical Factors in Healthcare Investing