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Rx for buying health care stocks

August 29, 2012: 8:08 AM ET

The high court's ruling cast a spotlight on this sector, but look past health care reform's early winners.

This column appeared in the September issue of Money magazine.

By Paul R. La Monica

After the Supreme Court upheld the Affordable Care Act, the prognosis for health care shares generally improved. Some managed-care companies and hospitals were dubbed big winners, since reform's survival means that more Americans will probably utilize -- and have the coverage to pay for -- medical services.

While the ruling clearly lifted a huge uncertainty from this sector, it's naive to think that Chief Justice John Roberts had the last say on reform. "Republicans and Democrats have been fighting about health care since Theodore Roosevelt was president," says Les Funtleyder, a manager at Poliwogg, a hedge fund that specializes in health care stocks.

Related: Hedge funds bet on Obamacare

So instead of focusing on the immediate beneficiaries -- which would, after all, lose the most if health laws were overhauled again down the road -- stick with companies that stand to grow in the long run with or without reform, says Peter Tuz, a manager with Chase Investment Counsel.

Fast pharma

This list includes medical-device makers and some fast-growing drug stocks. It's a simple matter of demographics, argues Funtleyder.

As baby boomers age, they will need to see their physicians more often. Increased doctor visits, coupled with broader coverage, mean more prescriptions. Tuz's fund, Chase Growth, owns drugstore giant CVS Caremark, which controls nearly 20% of the retail prescription-drug market.

Other stocks he likes: generic-drug maker Perrigo, which benefits from the surge in store-brand over-the-counter sales in this weak economy, and the specialty-drug and medical-device maker Allergan. Its flagship product, Botox, is being used for broader applications like migraines and urinary incontinence.

None of these stocks trade at rock-bottom price/earnings ratios. In this slow-growing sector, though, dirt-cheap stocks often deserve to be. CVS, Perrigo, and Allergan, by contrast, are expected to post annual earnings gains of at least 12% for the next five years.

Investors without borders

Another place to look for fast-growing health care companies is overseas.

"The growth in health care is likely to be mostly outside the U.S.," as access to medical services improves in the developing world, says Joe Costigan, director of equity research at Bryn Mawr Trust. Costigan's fund owns Mindray Medical, a Chinese maker of diagnostic devices whose earnings are rising 15% annually.

Prefer investing in foreign stocks through a mutual or exchange-traded fund? Among the top holdings of SPDR S&P International HealthCare Sector ETF  is Novo Nordisk. The Danish drug giant controls around half of the global market for insulin, and its earnings are forecast to grow nearly three times as fast as the pharmaceutical sector's.

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