1. Maisy Lam
FIN 431 – Lawandy
April 20, 2016
Sector Analysis – Health Care
Executive Summary
Health Care companies provide products and services related to health and medical care.
The Health Care sector can be argued as having the most critical role in daily life
compared to other sectors. Typically, the Health Care sector is economically less
sensitive and less volatile than the broad market, resulting in consistent performance.
Given the current state of the bullish market, Health Care can be expected to perform
above the S&P 500 by the end of the year. However, with the global environment
characterized by low to negative interest rates, devaluing currencies, and low oil prices,
sector performance is at risk because Health Care operates in a large, global market
where external circumstances affect all players. The Health Care team recommends still
investing in the Health Care sector. Since global environments are a key driver in the
short term, Health Care may see an increase in price since cost increases on the supply
side are passed down to U.S. consumers. The current price of the S&P 500 Health Care
index as of April 14, 2016 was $810.05.
Composition and Industries
The healthcare sector consists of two main industry groups: 1) Pharmaceuticals,
Biotechnology, and Life Sciences as well as 2) Health Care Equipment and Services. The
Pharmaceuticals, Biotechnology, and Life Sciences industry group is involved in
discovering, developing, manufacturing, and distributing prescription drugs. The Health
Care Equipment and Services industry group consists of health insurance firms,
pharmacy benefit managers, hospitals, technology firms, and medical equipment makers.
Each industry group consists of three industries. Under the Pharmaceutical,
Biotechnology, and Life Sciences industry group, the three industries are: 1)
Pharmaceuticals, 2) Biotechnology, and 3) Life Sciences Tools and Services. Under the
Health Care Equipment and Services industry group: the three industries are: 1) Health
Care Equipment and Supplies, 2) Health Care Providers and Services, and 3) Health Care
Technology.
The Health Care sector has a total market cap of $4.51 trillion. Within the overall Health
Care sector, the ten largest constituents by market capitalization are: Johnson & Johnson,
Pfizer Inc, Novartis AG (ADR), Merck & Co Inc, Gilead Sciences Inc, UnitedHealth
Group Inc, Amgen Inc, Sanofi SA (ADR), Novo Nordisk A/S (ADR), and Bristol-Myers
Squibb.

2. Pharmaceuticals
The Pharmaceutical industry includes firms that discover, develop, manufacture, and sell
prescription drugs to treat animals and humans. Pharmaceutical drugs are composed of
small molecules (i.e. chemicals), and pharmaceutical companies tend to offer a more
diversified offering of drugs compared to biotechnology. The three largest firms within
the pharmaceutical industries are: Johnson & Johnson, Novartis, and Pfizer.
Biotechnology
The Biotechnology industry includes firms that also discover, develop, manufacture, and
sell prescription drugs to treat animals and humans. Biotech drugs are composed of large
molecules (i.e. living organisms such as protein). Biotech drugs attempt to treat specific
diseases that currently do not have a cure (i.e. HIV). As a result, biotech drugs are
typically much more expensive, and the majority of biotech’s revenue comes from a
small handful of drugs. The three largest firms within the biotechnology industries are:
Gilead, Amgen, and Biogen.
Life Sciences Tools and Services
The Life Sciences Tools and Services industry supports both the pharmaceutical and
biotech industries by providing equipment, analytical tools, and supplies in addition to

3. research services such as clinical trials. The three largest firms within the life sciences
tools and services industries are Danaher Corp, Thermo Fisher, and Illumina Inc.
Health Care Equipment and Supplies
The Health Care Equipment and Supplies industry has firms that manufacture medical
equipment and general medical supplies. The three largest firms within the health care
equipment and supplies industries are Johnson & Johnson, General Electric, and Roche
HLDG-GENUS.
Health Care Providers and Services
The Health Care Providers and Services industry have firms that offer a range of service-
based products that are sold to individuals as well as other companies. The three largest
firms within the health care providers and services industries are: UnitedHealth Group,
Express Scripts Holding Company, and Aetna.
Health Care Technology
The Health Care Technology industry consists of firms that help gather and process data
as well as firms that provide software to streamline operations of the healthcare industry.
The three largest firms within the health care technology industries are: Cerner
Corporation, Premier Inc, and Chemed Corporation.

4. S&P 500 Sector Breakdown
The Health Care sector represents 14.3% of the S&P 500 market cap.
The Health Care Sector and Historic Returns
Historical Performance

5. Total Returns
Standard Deviation of Annualized Risk-Adjusted Returns
Total Returns by Industry
The Health Care sector outperformed the S&P in the three, five, and ten-year returns, but
underperformed the S&P trailing 12 months and the current year-to-date 2016. Health
care has a higher standard deviation, but that is due to the volatility within biotechnology
and health care technology industries. Within industries, four out of the six are
underperforming year to date, but overall every industry generates positive returns in the
long run. The Health Care sector’s recent under performance can be attributed to global
market conditions that have affected currencies, oil prices, interest rates, and emerging
markets which ultimately impact the sector. However, the S&P has been performing very
well, indicating a strong U.S. market.
Financial Analysis (See Valuation Graphs)
Gross Margin
Compared to the S&P, gross margin for Health Care is slightly higher, indicating that the
sector as a whole does not retain significantly more revenue per dollar of sales. This can
be explained by the high costs associated with discovering, developing, manufacturing,
and distributing health and medical goods and services. Interestingly, aside from the
Health Care Providers and Services industry, every other industry within the Health Care
sector outperforms the S&P by a substantial amount. The two most notable industries
with the highest gross margins are biotechnology and health care technology. Their high
margins can be explained by the surge in demand for technology and biotechnology,
which allows firms to generate large amounts of revenue.

6. Operating Margin
Compared to the S&P, operating margin for Health Care is underperforming, indicating
that there is a discrepancy between selling/pricing and operating efficiency. Either firms
are not selling enough/not charging consumers the right amount, or they may have high
variable costs (e.g. labor or materials) that decreases overall operating income. Again,
aside from the Health Care Providers and Services industry, every other industry within
the Health Care sector outperforms the S&P. Biotechnology again has a significantly
higher operating margin amongst all industries. Their high margins can be attributed to
charging a premium for biotech products and services, which allows for higher revenue.
Profit Margin
Compared to the S&P, profit margin for Health Care is also underperforming, indicating
that Health Care has a larger cost/expense structure associated with its operations. Health
Care firms are known for having high investment and maintenance costs. However,
industries such as biotechnology and pharmaceuticals have the highest margins. The
prescription drug market is extremely profitable, with power given to the producing
firms; so higher profit margins are expected.
Return on Assets
Compared to the S&P, ROA for Health Care as an overall sector as well as its industries
are all outperforming the market. This can be explained by the notion that given higher
cost structures, firms are more inclined to efficiently manage their assets in order to
generate earnings. In addition, in high performing industries such as biotech and
healthcare technology, certain assets have limited timelines, so firms must generate as
much earnings as they can within a specific time frame before the asset goes obsolete.
Return on Equity
Compared to the S&P, ROE for Health Care as an overall sector is outperforming the
market, indicating that firms are using shareholder’s invested capital to effectively
generate a profit. With the exception of Life Sciences and Health Care Equipment and
Supplies, Health Care industries are also outperforming the sector and the market. Most
notably, Biotechnology is again the strongest performing industry as much of the cutting
edge medical research and treatment options come from biotech, allowing the industry to
attract significant capital investments.
Debt to Equity
Compared to the S&P, D/E for Health Care as an overall sector is significantly lower than
that of the market. The low D/E ratio can be attributed to Health Care firms who
generally do not use a lot of debt as part of their capital structure, with the exception of
Health Care Providers and Services. Health Care Providers and Services include health

7. care facilities, which usually require more debt financing to build facilities such as
hospitals and clinics.
R&D Expense
Interestingly, compared to the S&P, R&D expense for Health Care as an overall sector is
significantly lower than that of the market. The low R&D expense be explained by the
little to no R&D spending acquired within the Health Care providers and services, life
sciences, and health care technology industries. Not surprisingly, R&D expense for
biotech is extremely high given the experimental nature of the industry in trying to
discover new drugs and treatments for incurable diseases.
Earnings per Share
Compared to the S&P, earnings per share for the Health Care sector drastically
underperform the market. This phenomenon can be explained by the low betas associated
with Health Care compared to other sectors in the market. With lower risk come lesser
returns. However, biotech is the only industry where EPS are significantly higher than the
market earnings. The nature of biotech as an industry is much more risky and therefore
lends itself to yield greater earnings for investors.
Valuation Multiples and Analysis (See Valuation Graphs)
Price to Earnings
Health Care as a sector consistently has a higher P/E ratio than the S&P. The higher ratio
indicates the market’s belief in the growth potential of the Health Care sector. However,
upon further investigation, the primary industries driving this growth are Health Care
Technology and Life Sciences Tools and Services.
Price to Cash Flow
Price to cash flow ratios across all Health Care industries are higher than the P/CF ratio
for the S&P. The significantly higher P/CF ratios indicate potential overvaluation due to
growth prospects placed within the Health Care industries.
Price to Sales
Compared to the S&P, the Health Care sector is on par with the market in terms of the
P/Sales ratio, indicating that the overall sector is adequately priced. However, when
individual industries are explored, biotechnology and health care technology are the two
industries that have the highest P/Sales ratios. The high ratios are consistent with the
dynamic nature of both industries. However, the high ratios can potentially raise the
question of overvaluing stocks within both industries. However, the market is showing
confidence in the growth potentials of both industries.
Price to Book
The Health Care sector has a consistently higher price to book value compared to the
S&P, indicating that health care stocks are valued higher than the market. However, the

8. sector’s higher P/Book ratio is primarily driven by the biotechnology and health care
technology industries. The P/Book value for both industries is significantly higher than
the other industries within the sector, indicating a current sentiment of over-valuation in
the stocks within both industries.
Conclusions
All the valuation multiples indicate that stocks within the Health Care sector are valued
higher than the market. Although growth potential in biotechnology and health care
technology industries are high, a higher valuation may raise potential concerns. Investors
should be aware of the risks that are associated with investing in high growth industries,
as they have a tendency to form bubbles and pop. Technology is a constantly changing
industry where technologies can become obsolete overnight and biotechnology industries
are only successful if positive results come from the experimental drugs and treatments.
Macroeconomic Analysis
The Health Care sector is plagued by limited supply and increasing demand.
Interestingly, because Health Care is relatively economically insensitive, the sector as a
whole tends to be described as defensive meaning that it can perform well when
economies contract and broader markets decline. However, there are additional economic
and social factors for investors to consider.
Economic
GDP
Government spending plays a large role within the Health Care sector as government
spending subsidizes a large portion of health care products and services. In 2015,
government spending on health care totaled $937 billion dollars and was the largest
government expenditure. If government spending is expected to decline, then there are
large implications for all industries within the health care sector.
Interest Rates
The Health Care sector is characterized by high capital investment and expensive cost
structures. As interest rates are anticipated to rise in the US, financing becomes more
costly for the health care industries such as health care providers and services. Higher
interest rates may decrease incentives for health care providers and services to expand
their portfolio of businesses in order to serve the increasing demand for health care
products and services.
Government Regulation
The Health Care sector is highly regulated by the government, but the upcoming
Presidential election will have a large effect on the sector. The outcome of the
presidential election may affect Obamacare with the potential for insurance companies to

9. exit the current system, increasing premiums and decreasing insurance providers
provided to Obamacare users. In addition, rumors of price regulation of drugs and
services may have large implications for the sector and shift the bargaining power away
from suppliers.
Global Dependence on US Market
The Health Care sector is a large global market that is dominated and centered on the US.
With the unstable global market, the US market may see an increase in price within the
health care sector as firms pass the cost increases down to US consumers in order to
continue providing products and services at a lower cost to global markets.
Social
Inelastic Demand
The Health Care sector is characterized by inelastic demand, meaning that regardless of
the economic environment, consumers will always possess a need for health care.
Currently, demand for health care products and services exceed the supply, and this
discrepancy shows no sign of slowing down. This phenomenon has serious implications
for consumers and the sector may experience overall price increases.
Population and Demographics
Population growth and the aging population are growing. Growth in these two areas will
further increase the demand for health care products and services. As a result, prices
within the Health Care sector may increase as well.
Income and Accessibility
When consumers have more disposable income, they are more likely to have access to
more health care products and services and as a result, spend on health care. With the US
markets showing strength and consistent growth in the foreseeable future, the Health
Care sector may see an increase in health care investors.
Education
Education plays a large role in the Health Care sector. Currently, the US tends to over
prescribe and over treat patients for medical conditions. If this trend continues, profits in
the Health Care sector can be anticipated to grow. However, if education increases,
consumers may be less inclined to invest as much in the health care industry.

10. Sector Outlook
Fidelity
Fidelity’s 2016 outlook for the Health Care sector is that performance will be similar to
that of 2015. However, there is greater policy risk because it is an election year, but the
risk is not threatening enough to initiate to a structural change. The aging global
population, emerging middle class in developing countries, and new innovation are three
long term trends that are expected to boost revenue on par with 2015 revenue. Notably,
medical equipment stocks will benefit from innovation. A decline in the US
unemployment rate and the Affordable Care Act increase the amount of people that visit
the doctor. Fewer patents are expected to expire in 2016, and specialty pharmaceutical
companies could potentially have a positive impact on sales. The election year poses
questions pertaining to new prescription drug pricing. Lastly, uncertainty will create
volatility in the short term, which long-term investors may choose to take advantage of.
S&P Global Market Intelligence
According to S&P Global Market Intelligence, the Health Care sector has reasons to
continue outperforming the market as well as face challenges in its performance ahead.
Earnings growth deceleration from 14.7% to an expected 10.7% may cause investors to
turn to other sectors. M&A activity and the debate over drug prices will continue to be a
topic throughout the upcoming election, with both situations likely to hinder
performance. High deductible and high co-payment plans will deter citizens from
enrolling for health insurance, forcing a miss in Congress's projections. Overall, there
will be an increase in volatility in the Health Care sector due to the vastly differing
opinions present throughout the presidential election and the sentiment of uncertainty. On
the other hand, continued sales growth and NME approval are a reason for optimism.
Global expansion and the aging population will continue to drive demand. A win for the
Democratic Party, preferably Hillary Clinton, would be the best scenario for the sector, as
there is certainty in her inability to pass the initiatives that could threaten the sector. For
the first time since 2011, the Health Care sector is trading at a discount to the market.
Most notably biotechnology companies are outperforming by the greatest amount, and
are expected to continue to do so.
Deloitte
Deloitte believes the macroeconomic issues of the global health care ecosystem are based
upon decreasing costs as sector fragmentation, population health, and volume to value
make the current situation unsustainable in the long term. As the population ages and
people need more medical attention, managing patients needs and meeting their high
expectations is key. As demand rises, many countries are looking to reform their health
care systems to keep government expenditure manageable. Overall efficiency regarding
every aspect of the industry, especially within the value chain and technology will
become even more imperative.

11. Fox Business
At the end of the first quarter, FactSet published that 61% of analysts recommend health
care as a buy since they anticipate revenue growth of 8.9% for Q1 2016. S&P Global
Market Intelligence estimates 2.9% earnings growth for Q1. Health care technology is
anticipated to have sales growth of 17% with biotechnology close behind at 12%. There
are many ETF’s that are weighted accordingly including: XLV, IYH, VHT, IHI, XHE,
etc., all of which the authors of Fox Business recommend for investors.
Wall Street Journal
UnitedHealth Group, the largest U.S. health insurer, is exiting Obamacare from a few
states in 2017 due to the instable costly nature of the Act. According to CEO Stephen
Hemsley, UnitedHealth Group’s expected Affordable Care Act losses for 2016 are $650
million dollars, up from $475 million last year, and has continued increasing since the
beginning of the year. Among other reasons, the increase in loss is due to the fact that
people can seek Obamacare’s medical coverage in anticipation of incurring a medical
expense, with the option to drop it after. Blue Cross Blue Shield Association has
estimated that Obamacare consumers in 2015 had medical costs that were 22% higher on
average than those with employment based coverage. If UnitedHealth quits all
Obamacare markets, it will cause higher premiums for Obamacare, and further increase
the potential for other insures to follow suit and drop Obamacare. Although Obamacare
may not be meeting its original expectations at implementation, exiting would not be
good for the market. Democrats Hillary Clinton and Bernie Sanders are actively looking
towards a single payer system, which continues to be a main topic of debate in the
upcoming election.
Porter’s Five Forces Model
Threat of Entry
The threat of entry is low because the Health Care sector is characterized by high initial
capital investments, large cost/expense structures, and strong regulation. In addition,
industries are dominated by a small number of firms, each of which hold tremendous
market share in their respective industries. Given the high M&A nature of the sector,
even if a small company is performing well and experiencing high growth, they will
typically be acquired by a larger, more dominant firm.
Threat of Substitutes
Depending on the industry, the threat of substitutes varies. Within the pharmaceutical,
life sciences tools and services, and health care equipment and supplies industries, the
threat of substitutes is high because products and services tend to be generic, resulting in
competitive price wars. On the other hand, in industries such as biotechnology, health
care providers and services, and health care technology, the threat of substitutes is low,
but innovation is key to maintain profitable.

12. Power of Suppliers
The power of suppliers is high within the health care sector because demand for
healthcare products and services tremendously exceeds the supply. Specifically, within
the Health Care Providers and Services industry, the suppliers have high bargaining
power simply because such high demand exists for services such as insurance and
physicians. In addition, drug companies who have product patents on medications allow
firms to charge a price premium.
Power of Buyers
The bargaining power of buyers in the healthcare sector is weak because the bargaining
power of suppliers is so high. If a consumer wants health care coverage they must pay the
asking price, with little to no negotiation power since insurance companies deal directly
with companies rather than individuals. In addition, consumers are at the mercy of
pricing advantages that suppliers have on medication. Overall, there is a high opportunity
cost of forgoing health products and services, so individuals are more willing to pay the
price set by suppliers.
Rivalry Among Existing Competitors
Rivalry among existing competitors is high within health care industries. Within the
pharmaceutical and health care equipment and supplies industries, most products and
services are generics. Since generics can be essentially treated as a commodity, price
wars to gain market share and revenue are typical within these two industries. Within the
health care providers and services industry, rivalry among existing competitors such as
insurance companies is high. Since demand exceeds supply, there are large opportunities
for profit and every player wants to capture as much of the market as possible.
Recommendation
Given the defensive nature of the Health Care sector and inelastic demand for health care
products and services, we recommend investing in the Health Care sector for generating
consistent long-term returns that surpass market returns. Within industries, biotechnology
and health care technology are the primary drivers of growth and sector performance.
However, with greater performance comes greater risk. Volatility within biotech and
health care technology industries is higher compared to other health care industries.
Investors should invest in biotechnology and health care technology firms, but should
also diversify some of the added risk associated with those industries by investing in less
risky health care industries.

13. Sources
Bloomberg
Deloitte (http://www2.deloitte.com/jo/en/pages/life-sciences-and-
healthcare/articles/global-health-care-sector-outlook.html and
http://www2.deloitte.com/us/en/pages/life-sciences-and-health-care/articles/2015-health-
care-providers-outlook.html)
Fidelity (https://www.fidelity.com/viewpoints/investing-ideas/2016-outlook-healthcare)
Fisher Investments on Health Care
Fox Business (http://www.foxbusiness.com/markets/2016/04/11/unloved-health-care-
etfs-may-surprise-this-earnings-season.html)
Google Finance
S&P Dow Jones Indices (http://us.spindices.com/indices/equity/sp-500-health-care-
sector)
S&P Global Market Intelligence (http://www.spcapitaliq.com/our-
thinking/ideas/healthcare-our-2016-outlook)
Wall Street Journal (http://www.wsj.com/articles/a-big-obamacare-exit-1461106087)

14. Financial Graphs
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18. Valuation Graphs (Note: Incomplete Data Set)
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