4 Picks for the Healthcare Rebound

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John Reese submits:

For much of the two-year-plus stock market rally, the healthcare sector has been left far behind the rest of the market. From the March 9, 2009 low through Feb. 23 of this year, for example, the S&P 500 gained more than 93%; the Healthcare Select SPDR exchange-traded fund ( XLV ), meanwhile, gained less than half that -- just 46.3%.

That's changed recently. While the rest of the market has stumbled amid the turmoil in the Middle East and the tragic earthquake and tsunami in Japan, many healthcare stocks have pushed higher. And year-to-date, long-term care facilities, medical care, and health care plans are all among the top industries in terms of year-to-date returns, according to Morningstar.

Even with their strong performance in recent months, many healthcare stocks still look quite attractive to my Guru Strategies, each of which is based on the approach of a different investing great. With fears about the healthcare bill starting to subside, and with fears of an economic slowdown causing many investors to focus more on defensive areas of the market, I thought it would be a good time to take a look at some of the healthcare plays my models are highest on right now.

Catalyst Health Solutions Inc. ( CHSI ) : Based in Maryland, this pharmacy benefits manager ($2.4 billion market cap) earlier this month purchased Walgreen's ( WAG ) PBM operations for $525 million, in a deal that increased its membership from 7 million to 18 million. Shares have surged about 20% since then, but two of my models think Catalyst is still a good buy at its current price.

One is my James O'Shaughnessy-based growth stock model, which looks for firms that have upped earnings per share in each year of the past five-year period, which Catalyst has done -- even in the face of one of the nastiest recessions on record. The model also looks for a key combination of variables: A high relative strength, which is a sign the market is embracing the stock, and a low price/sales ratio, which is a sign it hasn't gotten too pricey. Catalyst has a solid 12-month relative strength of 68, and its P/S ratio of just 0.64 comes in well below this model's 1.5 upper limit.

My Martin Zweig-based growth model also likes Catalyst. It looks at earnings growth from a variety of angles, and Catalyst passes most of its tests. The firm has grown EPS at an impressive 25.7% rate over the long term (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate), and it's also getting its growth from revenues, rather than one-time cost-cutting measures. Sales have grown at a 32.6% rate over the long term, and an even-better 49.3% rate in the most recent quarter.

AmSurg Corp. ( AMSG ) : Based in Nashville, Tenn., AmSurg owns and operates a network of more than 200 ambulatory surgery centers across the U.S., in partnership with physicians. The small-cap ($788 million market cap) hasn't had one annual EPS drop in the past decade, despite the tough economic conditions that often prevailed.

AmSurg gets very high marks from the model I base on the writings of hedge fund guru Joel Greenblatt. In his Little Book that Beats the Market , Greenblatt unveiled a remarkably simple approach that examined only two variables: Earnings yield and return on capital. AmSurg excels in both categories, with a 22.1% earnings yield and a 105.9% return on total capital. Those figures make AMSG the third-most-attractive stock in the market, according to this model.

My O'Shaughnessy-based growth model also likes AmSurg, which has a decent 55 relative strength and an attractive 1.1 price/sales ratio.

Alcon, Inc. ( ACL ) : The largest specialty eyecare company in the world, Alcon ($50 billion market cap) has operations in 75 countries and its products are sold in more than 180 countries. The firm is majority-owned by Novartis (NVS), incorporated in Switzerland, and has a U.S. base in Texas.

Alcon gets high marks from my Warren Buffett-based strategy. This approach looks for firms with lengthy histories of earnings growth, manageable debt, and high returns on equity (which is a sign of the "durable competitive advantage" Buffett is known to seek). Alcon delivers on all fronts. Its EPS have dipped in only one year of the past decade; it has no long-term debt; and it has averaged a 38.2% ROE over the past 10 years, more than two-and-a-half times this model's 15% target.

Universal American Corp (UAM) : This Rye Brook, N.Y.-based firm and its subsidiaries offer a variety of healthcare products, including traditional health insurance, Medicare managed care plans, and Medicare prescription drug benefits, focusing primarily on senior citizens.

Universal American ($1.7 billion market cap) gets high marks from my Peter Lynch-inspired model, which considers the stock a "fast-grower" thanks to its 25.1% long-term EPS growth rate. Lynch famously used the P/E/Growth ratio to find undervalued growth stocks, looking for P/E/Gs below 1.0. When we divide Universal American's 10.0 P/E ratio by its growth rate, we get a P/E/G of just 0.4 -- a sign that it's a bargain.

For financial firms, this approach looks for companies with an equity/assets ratio of at least 5% and a return on assets rate of at least 1%. At 41.0% and 5.02%, respectively; Universal easily passes both tests.

Disclosure: I am long CHSI, AMSG, UAM.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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