Top Health Care Stocks With Solid Fundamentals and Strong Sentiment

With almost three quarters of the year already in the books, the stock market sits three to five percent below where it ended 2010, depending on the benchmark you use. With correlations between all sectors of the economy, as represented by S&P’s sectors, near 1% and with stock markets in Emerging and Developed economies moving in virtual lock-step, it is clear the U.S. stock market is simply a passenger on the global macro-economic train. Macroeconomic concerns and economic policy coming out of Europe and Washington seem to, at least for the moment, be trumping stock selection. However, from MarketGrader.com’s point of view, health care companies’ shares have been handily outperforming the broader market and stocks in virtually all other sectors. We measure the performance across different stock market sectors according to our own, narrowly defined sector indexes. Unlike most broad sector benchmarks, the MarketGrader Sector Indexes are limited to 40 stocks each, all equally weighted, rebalanced quarterly and selected on the basis of their overall fundamental grade. These are, therefore, the highest graded stocks in any given sector and in the case of health care, the best ones out of more than 600 companies we follow in the space.

The list below highlights the top five health care stocks in the MarketGrader Health Care index based not only on their fundamentals but also on their Sentiment score, which tracks price trend, momentum, earnings estimate revisions and short interest fluctuations for each stock in our system in order to gauge overall investor appetite for a company’s shares, irrespective of fundamentals. The MarketGrader Health Care index, which had its quarterly reconstitution last month, is up almost 9% year to date and 15.5% in the last three years. It has done particularly well in the last month, up 8%. You may view the complete list of stocks in our Health Care index for free by clicking here. The following are our top five selections:

1. Computer Programs & Systems Inc. (NASDAQ: CPSI)

This provider of computer technology systems and applications to the health care industry appears well positioned to profit from the growing trend to digitize medical records and its growth record appears to support this. Its most recent trailing 12-month revenue of $173 million was 53% higher than it was in the equivalent period three years ago while profits grew 83% to $24.8 million during the same time frame. The company has no debt, a remarkable 48% return on equity and a whopping 75% return on invested capital, both based also on trailing 12-month results. Its shares, however, don’t come cheap, trading at 32 times trailing and 25 times forward earnings per share. The stock, however, seems to be carried by strong momentum with an overall Sentiment score of 9.6 (out of 10.) And even if the share price were to face some headwinds in this volatile market, the stock’s 2% dividend yield, unusually generous for a $793 million market cap company, should provide a decent floor under it. Based on a MarketGrader overall grade of 82.0 the company ranks seventh among all Health Care stocks in our coverage universe.

2. Jazz Pharmaceuticals Inc. (NASDAQ: JAZZ)

With an overall grade of 88.6, JAZZ is the third highest graded stock in the sector, according to MarketGrader.com. The $1.79 billion company, which develops neurological and psychiatric drugs, earned $92.73 million in the 12 months ended last quarter on sales of $213.75 million, which represents a 218% increase in a three-year period. With gross and net margins of 91% and 43% respectively on a trailing 12-month basis, it is little surprise the company posted a 91% return on equity and 95% return on invested capital over the same time period. Its shares, although trading near their 52-week high of $45, exchange hands at 21 times trailing earnings and only 9.6 times next year’s estimates. JAZZ, which has been using its cash to pay down its debt in the last two years, generated $37.3 million in free cash flow last quarter and does not pay a dividend. With $102.4 million in cash on hand the company looks not only like a potential acquisition target but increasingly as an acquirer too. (JAZZ announced after Monday’s close the acquisition of privately held Azure Pharma, based in Ireland, in an all-stock transaction. The value of the transaction, announced officially as a merger, was approximately $360 million.) Sentiment score: 9.4.

3. HealthSpring Inc. (NYSE: HS)

This $2.6 billion provider of supplemental Medicare and Medicare Advantage plans has an overall grade of 72.7 and a Sentiment score of 8.7. The company earned $233 million in the last 12 months on revenue of $4.38 billion. While it also generated $202 million in free cash flow during the period, its negative $12.15 million in cash flow reported last quarter underscores the difficult environment in which managed health care providers operate. HealthSpring’s operating margin in the last 12 months was 8.8% while its return on equity was 14.6%. The company has $345 million in debt and only $83 million in net debt when taking into account its cash on hand. The stock trades at only 10 times 12-month trailing earnings per share and 8.9 times next year’s consensus estimate.

While the stock appears inexpensive based on its value ratios, it’s important for investors to note that existing shareholders were diluted pretty significantly when the company floated 7.5 million shares last quarter, raising approximately $260 million, 50% of which the company expected to use to pay down debt. The balance, it said, would be used for acquisitions. On a per share basis, according to our calculations, existing shareholders forfeited $0.24 per share in earnings last quarter as a result of the offering. If this total were added to the $1.23 fully diluted earnings per share reported by the company, the stock would now be trading at an even lower 9.5 times trailing EPS, almost in line with its forward P/E ratio.

4. Hi-Tech Pharmacal Co. Inc. (NASDAQ: HITK)

The highest rated pharmaceutical company in MarketGrader, Hi-Tech Pharmacal manufactures a wide range of retail health products that range from cough medicine to eye drops and vitamin supplements. The $442 million company earned $46.6 million in the 12 months ended last quarter, on $208.3 million in revenue. In the quarter ended on July 31st its sales and net income grew by 39% and 59% respectively. Also on a trailing 12-month basis the company posted a 24% return on equity with gross margins of 55% and operating margins of 31.4%, ahead of the pharmaceutical industry average 16.85% operating margins. HITK shares currently trade at $35, 9.7 times trailing earnings per share and only 12.7 times next year’s consensus estimate. The company has virtually no debt, generates an excess of $10 million in free cash flow per quarter and holds $78 million in cash on hand. Its Sentiment score is 8.7.

5. Intuitive Surgical Inc. (NASDAQ: ISRG)

While ISRG is one of the most richly valued stocks in the MarketGrader Health Care index, the company’s growth continues to defy skeptics. Intuitive Surgical developed and manufactures the Vinci Surgical System, a remote controlled range of motion surgical robot that assists surgeons with high precision procedures. The company has been growing its top and bottom line at an average rate of 32% and 35% annually in the last five years. During its last 12 months alone revenue more than doubled from three years earlier to $1.55 billion while net income jumped 130% to $429.3 million. During that same period the company generated more than $420 million in free cash flow and had a 19% return on equity. ISRG trades at 37 times trailing EPS and 29 times next year’s estimated earnings. It has a Sentiment score of 9.4.

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