Not that it needed it. Health care names have rallied 4.7% since the calendar flipped to January, stomping the 1.69% gains that the rest of the S&P 500 have barely eked out. Big hedge funds have actually been positioned really well to take advantage of that upside too: Funds picked up stocks from the health care sector more than any other industry group last quarter.
Thing is, none of their biggest conviction health care buys were the ones that made the headlines yesterday.
Want to know what the "smart money" is buying in 2014? Then we've got to take a closer look at 13F filings.
Institutional investors with more than $100 million in assets are required to file a 13F, a form that breaks down their stock positions for public consumption. From hedge funds to mutual funds to insurance companies, any professional investors who manage more than that $100 million watermark are required to file a 13F.
In total, approximately 3,700 firms file 13F forms each quarter, and by comparing one quarter's filing to another, we can see how any single fund manager is moving their portfolio around. While the data is generally delayed by about a quarter, that's not necessarily a bad thing. Research shows that applying a lag to institutional holdings can generate positive alpha in some cases. That's all the more reason to crack open the moves being made with pro investors' $19.3 trillion under management. It's early in 13F filing season still, and that means we're getting an early sneak peek at the few names institutional investors love right now.
Today, we'll focus on hedge funds' five favorite health care stocks.
Johnson & Johnson
Hedge funds may be well-positioned in the health care sector, but don't accuse them of being too creative. Funds' biggest health buy in the first quarter was $283 billion blue chip Johnson & Johnson (JNJ). Funds piled into JNJ with 816,830 shares, an $81 million stake at today's price levels.
So should you follow them in?
Johnson & Johnson is the bluest of the blue chips. The firm is the biggest health care stock in the world, with major consumer brands like Band-Aid, Tylenol, Neutrogena and Acuvue under its belt. But it's the firm's non-consumer pharmaceutical and medical device units that are the real revenue drivers for JNJ in the years ahead. For that reason, Johnson has been investing significant cash into those businesses, particularly the medical device segment with its Synthes acquisition in 2012.
At first glance, all of the cash pouring into JNJ this year looks like a flight to quality as momentum names have rolled over. After all, this big blue chip generates substantial cash and carries a pristine balance sheet with more than $6 billion in cash on the books. But that money flow looks far more like a flight to yield -- it's Johnson & Johnson's 2.64% dividend payout that's drawing investors' money in 2014.
Either way, investors in search of health care exposure could do worse than JNJ right now. A lot worse.
Baxter International (BAX) is another health care name that pro investors bought in a big way last quarter. Funds picked up 3.34 million shares of BAX to start the year, boosting their ownership by more than 20%. That puts those funds' positions in Baxter at nearly $1.4 billion as I write. And there's a lot of reason to believe that Baxter has substantial upside ahead of it for the rest of 2014.
Baxter is a leader in the injectable therapies market, manufacturing everything from IV bags and solutions to dialysis equipment. The firm made a $4 billion bet on dialysis last year when it bought Swedish dialysis treatment manufacturer Gambro last September. The rest of Baxter's business is built around more specialized niche medical treatments. By pouring R&D resources into a small medical area, it's able to capture the market-leading position quickly and collect bigger margins for taking the risk.
The other side of Baxter's business is a lot less exciting: the firm is a leading maker of medical products such as IV solutions and injectibles to hospitals and pharmacies. That unit may be a lot more boring, but it pays the bills medical products account for around half of sales right now. The decision to spin off the biopharmaceutical business in the middle of next year should give BAX a less bipolar model, and more important, it should unlock considerable shareholder value.
Funds love Pfizer (PFE) in 2014. No, buying up the world's biggest pharmaceutical firm isn't a particularly surprising move for health care exposure -- but at the same time that biopharmaceutical stocks are going gangbusters, PFE looks like a store of value that's being hidden in plain sight. Hedge funds added 1.92 million shares of Pfizer to their portfolios in the last quarter, a $60 million stake at current share prices.
Pfizer owns some of the world's most popular drugs, including household names like Lipitor, Viagra, Celebrex and Lyrica. A great deal of that success comes from a hugely effective marketing mechanism. That marketing prowess has helped the firm to minimize sales losses as blockbuster drugs fall off of patent protection. (Lipitor is a perfect example of that here in the U.S.) PFE has also been buying its way into a deeper drug pipeline, most notably with the acquisition of Wyeth in 2009. Several of the drugs in late stage development at Pfizer have blockbuster potential right now.
From a financial standpoint, Pfizer is in stellar shape. The firm currently carries $12.3 billion in net cash and investments, a safety net that effectively pays for 6.2% of the firm's market capitalization right now. That big cash cushion also gives PFE an ex-cash P/E ratio of 17; that's not a bargain bin valuation, but it's hardly a rich one either. A 3.35% dividend yield rounds out the picture in this pharmaceutical giant.
Mead Johnson Nutrition
Pediatric nutrition supplier Mead Johnson Nutrition (MJN) has built a lucrative deep margin business out of baby formula. The firm's Enfamil brand is hugely popular and owns a leading position in the premium end of the nutrition segment. While infant nutrition makes up around 60% of sales, MJN also makes nutrition products for older children.
Mead Johnson's international exposure is impressive. The firm earns 70% of its revenues in Asia and Latin America, giving it spectacular positioning for population among middle class consumers. Premium positioning doesn't have any drawbacks for Enfamil. New parents are willing to spend more on their children's nutrition needs, and lower-income families on the WIC program in the U.S. are able to buy MJNs Enfamil products without watching the price of formula. That gives this stock considerable recession resistance.
Look for MJN's exposure to emerging markets to be a big boon for shares in the coming years. That's what funds are betting on, anyway: Pro investors doubled their holdings in MJN in the most recent quarter, adding 2.38 million shares of MJN to their portfolios.
Last up on fund managers' buy list is CVS Caremark (CVS), the drugstore chain. CVS is one of the biggest retail pharmacy brands in the country, with more than 7,000 locations spread across the map. It's also one of the country's biggest pharmacy benefit managers, filling more than one billion prescriptions each year. That integrated drugstore and PBM operation cuts out the middleman, and gives CVS access to fatter margins.
Demographics are a big tailwind for CVS in the years ahead. An aging population is driving pharmaceutical volumes here at home, and that increased demand should help to fuel profits for CVS. The introduction of MinuteClinic health clinic locations at approximately 500 of CVS' retail locations is another important growth driver it gives customers a cheaper alternative to a doctor's office, and a big incentive to fill prescriptions in-house. That complete vertical integration of health care provider, benefits manager, and pharmacy also gives CVS a cost structure that's very attractive.
Funds picked up 1.21 million shares of CVS in the most recent quarter, boosting their holdings by $88.6 million at current price levels. CVS isn't the most exciting name in the sector or even the most exciting name on this list but it's a solid option for slow, steady growth.
To see these stocks in action, check out the Institutional Buys portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.