Healthcare: Policy Uncertainty Is Countered by Interest in Defensive Stocks

The US market has outperformed the Morningstar US Healthcare Index over the past 12 months, but the sector’s solid performance in the first quarter of 2025 narrowed the gap to less than 9 percentage points. Healthcare’s derailment in the fourth quarter of 2024 was largely tied to postelection uncertainties and disappointing news for large-cap biopharma and healthcare plan (managed care) stocks.

Healthcare Underperformed the US Market in 2024 but Narrowed the Gap in Q1

Following solid fourth-quarter results and 2025 outlooks across much of biopharma, as well as broader market uncertainty, healthcare stocks have risen but remain undervalued, with a median discount to our healthcare fair value estimates of 5%. Medical distribution stands out as the only overvalued industry, while healthcare plans and biopharma look the most undervalued.

Apart From Distribution, Most Healthcare Industries Look Undervalued

We expect the sector’s more defensive nature to support it if economic concerns continue, although government policy uncertainty is heightened under President Donald Trump and Secretary of Health and Human Services Robert F. Kennedy Jr. Within biopharma, the market is not fully appreciating innovation beyond obesity leader Eli Lilly LLY, which we think looks overvalued at recent prices.

We believe the new administration is unlikely to create significant new approval or pricing headwinds in biopharma, which is still digesting Medicare reforms as part of the Inflation Reduction Act. In managed care, we think shares look undervalued even in some of the more bearish scenarios for policy reform under a Republican-led administration. Device and diagnostic valuations are still stabilizing after falling from a period of overoptimism during the peak of the covid-19 pandemic.

Managed Care Organizations: Profit Mix Sorted by PBM Exposure

The 10 drugs selected for Medicare negotiation in 2026 as part of the IRA already had significant discounts to their list prices (48% on average), and we estimate that additional discounts average only 15%, with the potentially hardest-hit four drugs depicted below. Within managed care, we think pharmacy benefit managers remain in the crosshairs of the new administration, with Cigna Group CI and CVS Health CVS the most exposed. However, the most likely regulation—eliminating spreads and rebates—doesn’t seem a significant headwind.

Medicare Negotiations in 2026 Look Manageable

Top Healthcare Sector Picks

Baxter International

• Fair Value Estimate: $55.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High

Demand is improving in most of Baxter International’s BAX medical supply businesses because of rising medical utilization and product introductions like the Novum IQ pump platform. Baxter also represents a margin improvement story, as most inflationary challenges in its supply chain are easing and key new group purchasing organization contracts should help this year by boosting product pricing. The recent sale of its kidney care segment came through at a low price, and related costs will slightly weigh on margins through 2026. However, we expect management’s focus on growth and margins for the remaining business could boost shares eventually.

Moderna

• Fair Value Estimate: $102.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: None
• Morningstar Uncertainty Rating: Very High

We think Moderna MRNA investors were at first overly enthusiastic about the potential of the company’s mRNA technology during the pandemic, and have subsequently been too bearish on its post-pandemic growth. While we have modest expectations for sales of the firm’s covid-19 vaccine following massive pandemic-fueled demand in 2021 and 2022, we think Moderna’s pipeline of mRNA-based vaccines and treatments is advancing rapidly across multiple therapeutic areas. We’re confident in the long-term sales trajectory of the firm’s diversified pipeline, despite a competitive RSV vaccine market clouding near-term prospects.

Pfizer

• Fair Value Estimate: $42.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Medium

Following rapid declines in covid-related revenue, Pfizer PFE is hitting a trough in pipeline productivity, and investors have grown frustrated. However, we think the firm is seeing solid cost savings as it manages the transition back to a postpandemic market. We’re also bullish on the portfolio and pipeline the firm acquired with Seagen, which was one of the biggest investments it made with its covid-related profits. Overall, we think Pfizer’s diversified portfolio and strong cost management provide the necessary support for the firm’s dividend as it builds a strong pipeline for long-term growth.