Best and Worst ETFs In The Health Care Sector [SPDR S&P Biotech (ETF), iShares Dow Jones US Medical Dev.(ETF)]

Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5

Screen shot 2014-01-22 at 9.38.56 AM

* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Oak Associates Funds: Live Oak Health Sciences Fund (LOGSX) and Saratoga Advantage Trust: Health & Biotechnology Portfolio (SBHIX) are excluded from Figure 2 because their total net assets (TNA) are below $100 million and do not meet our liquidity standards.

iShares U.S. Medical Devices ETF (NYSEARCA:IHI) is my top-rated Health Care ETF and Delaware Group Equity Funds IV: Delaware Healthcare Fund (DLHIX) is my top-rated Health Care mutual fund. Both earn my Neutral rating.

State Street SPDR S&P Biotech ETF (NYSEARCA:XBI) is my worst-rated Health Care ETF and Rydex Series Funds: Biotechnology Fund (RYBOX) is my worst-rated Health Care mutual fund. XBI earns my Dangerous rating while RYBOX earns my Very Dangerous rating.

Figure 3 shows that 32 out of the 314 stocks (over 15% of the market value) in Health Care ETFs and mutual funds get an Attractive-or-better rating. However, no Health Care sector ETFs or mutual funds get an Attractive-or-better rating.

The takeaways are: mutual fund managers allocate too much capital to low-quality stocks and Health Care ETFs hold poor quality stocks.

Figure 3: Health Care Sector Landscape For ETFs, Mutual Funds & Stocks

Screen shot 2014-01-22 at 9.38.15 AM

Sources: New Constructs, LLC and company filings

As detailed in “Cheap Funds Dupe Investors”, the fund industry offers many cheap funds but very few funds with high-quality stocks, or with what I call good portfolio management.

Investors need to tread carefully when considering Health Care ETFs and mutual funds, as no Health Care sector ETFs or mutual funds receive an Attractive-or-better rating. Investors would be better off by focusing on individual stocks instead.

Medtronic Inc. (MDT) is one of my favorite stocks held by IHI and earns my Attractive rating. Medtronic Inc. has grown after-tax profits (NOPAT) by 14% compounded annually over the last 15 years and generates a return on invested capital (ROIC) of 13%. $11 billion inexcess cash and positive free cash flow in 9 out of the past 10 years also demonstrate the value MDT can create for investors. Despite this strong track record of profit growth, expectations for MDT remain low.  At its current trading price of ~$59/share, MDT has a price-to-economic book value (PEBV) ratio of 1.1.  This valuation implies that the market only expects Medtronic to increase NOPAT by 10% over the remainder of its corporate life. Such low profit growth expectations embedded in the stock combined with a strong track record of profit growth make MDT a low risk/high reward proposition.

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