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Health Care Provides Shelter from Economic Storm

Use this screen to find the best of health-care stocks, which historically tend to perform independently of the economic cycle.

Justin Fuller, 08/04/2008

Over the past several recessions, health-care stocks haven't skipped a beat and have shown strong resilience to a slowing economy. As the U.S. economy approaches a recessionary period, several health-care stocks should again generate consistently strong growth.

While uncertainty remains to the degree and length of the impending recession, health-care stocks as a whole should perform well regardless of the severity of the downturn. Our analysis shows that over the past several recessions, health-care stocks showed very minor correlation to the economy's growth. (See Is Health Care Immune to a Recession? for more on this topic.) We believe that the inelastic nature of health-care goods and services keeps demand high even when consumers face declining disposable income. Further, a large amount of health-care spending is composed of insurance payers, which shields consumers from the majority of expenses. Therefore, health-care stocks should offer a viable option in a slowing economy.

Morningstar tracks more than 1,000 health-care stocks, however, and sifting the winners from the losers is a challenge. Not all health-care stocks will perform well in recessionary periods. Further, many health-care stocks face company-specific risks that reduce the stocks' return potential. This screen seeks health-care stocks with the highest return potential in a slowing economy. We performed this screen in May in Morningstar Principia with April month-end data. An equivalent screen can be created in Morningstar Advisor Workstation Office Edition.

Initially, we want to group only the health-care companies out of the total stock universe:

Sector = Healthcare

Second, we want to avoid small companies, where slight missteps are magnified in a weakening economy. Lacking the diversity of several operations, small firms tend to focus on particular niche industries. In a weak economy, a small company's sole business line faces a greater risk of reduced demand. Without the stability of multiple operating divisions, any problems arising to the core business may result in the need to raise capital to get past the rough patch. In a recessionary period, generating additional capital through equity offerings can greatly dilute the existing shareholder base. As a result, we want to include only companies with market caps greater than $1 billion.

And Market Cap > 1000.00

Further, the credit markets have created major problems for companies carrying large amounts of debt. Even companies with reliable streams of cash flow can encounter challenges in the current credit markets. While health- care companies tend to carry a lower debt burden than companies in other sectors, to eliminate companies with heavy debt loads we set our debt/total cap ratio to less than 40%.

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