How to Play Healthcare in 2010

BOSTON (TheStreet) --Are price-to-earnings discounts the way to play healthcare stocks in 2010?

The chart above details some atypical discounts that developed in the healthcare sector.

The healthcare reform effort in Washington created mass uncertainty for healthcare stocks. And with healthcare reform nearing closure, some healthcare experts think attractive relative valuation should drive investors to the sector in 2010.

Healthcare consulting firm Leerink Swann, for one, estimates the healthcare discount at approximately 25% versus the broad market. What's more, the Boston-based firm thinks that should be enough to spur increased allocation to healthcare stocks.

The p/e discount is particularly great in certain healthcare sub-sectors.

Managed care, for example, is a healthcare sub-sector that Leerink Swann likes for the discounted valuation, especially Cigna ( CI) and WellPoint ( WLP).

Managed care has a 41% discount to the broad market, versus a 27% discount for the S&P 500 Healthcare Index.

Pharmaceuticals are trading at a pretty big 34% discount, too.

Leerink Swann believes that this big pharma discount had more to do with the rapid multiple expansion of the overall market in 2009, as opposed to a contraction in pharmaceuticals specifically. According to the healthcare consultant, risks to big pharma, including generic drug competition and healthcare reform, have already been priced into the shares.

Still, pharmaceutical stocks may be a good place to put the p/e argument for healthcare in perspective, and provide the counter-argument. After all, it is always good to get a second opinion when the subject is healthcare.

Avik Roy, a healthcare analyst with boutique New York City research firm Monness Crespi Hardt, says investors should remember that p/e is really a reflection of what the market thinks relative to the Street. Right now, Roy says all the healthcare p/e discount is telling us is that the market is more pessimistic than the Street.

What's more, Roy says that when playing healthcare stocks like the big pharmaceuticals, investors need to remember that Pfizer, for example, before its purchase of Wyeth ( WYEPR), has been a p/e laggard for years.

In the healthcare subsector of medical technology, stocks have historically traded at a premium to the S&P 500 -- an 18% premium to the S&P 500 forward p/e over the past five years.

That medical technology forward p/e premium has reversed recently, as the healthcare sub-sector is trading in-line with or at a slight discount to the broad market. Leerink Swann thinks this trend opens up the opportunity for multiple expansion in the medical technology sector in 2010, albeit at a modest level.

The bottom-line: for investors interested in the p/e argument for healthcare stocks, the prescription is clear: you must put a microscope to the stocks, sub-sector by sub-sector, to arrive at a proper diagnosis.

-- Reported by Eric Rosenbaum in New York.

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