Method to my Madness – Healthcare Portfolio

I’ve had a few questions of late about some inclusions & exclusions of stocks in my Healthcare Portfolio and wanted to provide some insight into my personal reasoning behind each choice, decision and how I originally constructed the portfolio. As many readers know my approach at times is unorthodox and goes against the grain of what most investors have been taught or possibly have experienced on their own.

I’ll first be very honest about my healthcare strengths & weaknesses. Being an acute-care nurse, I obviously have experience & exposure to a wide variety of healthcare products, drugs & new technologies that companies specifically tailor to the needs of patients; but I also have direct experience with a wide range of patients suffering all sorts of acute or chronic health issues. This not only gives me great insight into my own practice as a nurse; but also into the unique needs that patient’s have for products and services. Through some close relationships with employees of large corporations and the management running those companies I understand what key information I need to assess in order to gain a sense of investing opportunities for a specific of a drug, medical product or other service. Some of that experience has been through dealing directly with drug reps, trained professionals, seminars I attend or the relationships I’ve created through my own investigating of these individual companies.

I’ve spoken twice now on healthcare mutual funds in both part I and part II, but the main point I’ve attempted to make for readers is that the demographic shift is real & happening even though the investing opportunities through these mutual funds is fatally flawed. In order to capitalize on this changing demographic of both age & demand you need to recognize the behaviour of the specific target market. When I talk about a target market I’m attempting to describe in very specific terms the exact group of individuals that I wish to identify; simply stating that the population is getting older is much too broad of term to accurately identify an investing opportunity. Some may disagree with me, but if you continue to read hopefully I’ll at least have you considering some of my points.

Identifying a target market isn’t rocket science – so don’t be discouraged. Although it may seem to be a complicated term used by most marketing types, it’s important to note that if you stick to a simple approach you’ll find that assessing a group is logical and something anyone can do with ease. My intention is not to argue at this time how or what a target market may be – simply discuss how I’ve assessed specific groups of individuals in this ageing demographic that I can use to invest in companies for my own financial benefit.

Moneygardener (Investor99) asked recently in response to one of my posts why I have Proctor & Gamble in my Healthcare Portfolio since a very small portion of their revenue & profit comes from pharmaceuticals.

As I mentioned in my post on Taking Stock in JNJ, I love brands – plain & simple. While some investors look to technical analysis or one of the many other ways to assess a company based on numbers; it’s no secret that I tend to focus a large portion of my time on the fundamentals of a business and assessing a company with my Value Rules. To me, that’s where more than 50% of the value comes from a stock when it’s undervalued. I’m not suggesting that you ignore the numbers because I do focus on them before making a decision or purchase of a stock – but too often I find that investors focus too closely on the valuation of a company in comparison to the fundamentals that drive the business.

My opinion is that the true value of brands can often be the most classic example of how some companies are undervalued on a fundamental basis. In the coming months I’ll be turning my focus towards a three-part series I’ve written on brands and be able to provide much better insight into how I’ve been successful to date in my investing activities by focusing on this one singular part of how a company sells. Remember that it’s not only the price, marketing & quality that sell a product but the brand power behind that name and the psychology of how, why, when & where we make our purchases as consumers.

As I mentioned at the beginning, my intention is to provide insight into the foundation of how this portfolio was constructed. If you remember back to Building an Investment Portfolio you’ll know that I talked about the importance of setting specific objectives for a portfolio. My Healthcare Portfolio is largely based upon the brand power of many companies who possess profitable, stable and growing opportunities of brands from a value perspective.

What I attempted to do in the construction phase of the portfolio was gain exposure to key categories of the healthcare field in order to adequately cover the entire demographic shift that I continue to see emerging in many different segments. If you think of the ageing population as being divided into 5-10 specific segments based on behaviour or trends, then understanding the specific holdings in the portfolio becomes much easier to identify. I hold companies such as the large Canadian insurance companies, consumer drugstores and specialty medical companies. While these specifically are more plays on the ageing population segment in my assessment of the target market others include exposure to specific pharmaceutical companies, medical device technologies, healthcare service or product suppliers & innovators in how healthcare technologies are delivered & processed.

PG offers my portfolio exposure to two key elements of these 5-10 categories: personal care and pharmaceuticals. If you look at the spending habits of many baby boomers, you’ll quickly notice that brand loyalty is usually extremely high. This segment of the market usually knows exactly what they want, are willing to pay a premium for a product or service and repeatedly return to the same product time after time (brand insistence). The emerging trend among them shows they are likely to have more discretionary income and spend that on high-end products that they perceive to offer benefits over other competition. These include products of personal care (everyday hygiene), leisure/comfort and disease prevention. PG already sells a large segment of these products to the baby boomers and has the competitive advantage in knowing how to not only reach them as a target market, but also understand their purchase behaviours in order to sell them more products more often. The sheer dominance of their brands/products on a scale of 1-10 puts most of their competition at less than a 5.

As with JNJ – simply looking at some of their top brands might not reveal much at first, but my comments following should help to strengthen the point:
– Crest, Vick’s, Braun, Fixodent, Scope, Oral-B, Gillette, Metamucil, Fibersure
– Pantene, Head & Shoulders, Herbal Essences, Aussie, Clairol
– Camay, Ivory, Noxema, Oil of Olay
– Pepto-bismol, Macrobid
– Tampax & Always
– Covergirl, Max Factor

So…what comes to mind at first…anything inspiring? How about the fact that none of these products can really be considered as generic. They’re priced above generic competition and the names of the products are easily recognized and often sell at a premium to their competition. My point? Consumers pay a premium for these products without much dissonance because of the benefits they perceive the products offer them. If you’ve taken a moment to look up my holding in NADX then Fixodent may become a logical compliment product. Macrobid is one of the most prescribed medications for bladder infections that most women have suffered from at some point in their life, in addition to feminine products such as Tampax & Always. Metamucil, although not the greatest, does do a great job of keeping individuals REGULAR.

Since PG has indicated recently (as I suspected they would) that they may be interested in selling off certain brands, my strategic analysis indicates that they may be on the hunt for a large acquisition by following their Do What You Do Best behaviour. PG is ever looking to expand their presence in specific markets and an acquisition may be one of their centre focuses in the future in addition to their initiatives of expanding new product offerings. It also never hurts to have just over $5B cash in the bank to pick off a struggling competitor if the consumer market begins to turn sour in the US or internationally.

So that’s my take on PG. Now for bindexit’s questions on Jean Coutu (PJC.A):

Following my explanation of the 5-10 categories that segment my Health Portfolio, an obvious investment would be to focus on where, when & how the ageing population will receive their drugs. The drugstore category doesn’t require as much focus as other segments in the portfolio, but I do have exposure to them. I believe that PJC.A is a good company, but I wouldn’t place it anywhere near the same level as Shoppers Drug Mart & my newest addition of Walgreen. In turning up an older SWOT with revisions I’ve made of recent activities:

– Their payout ratio appears to indicate the dividend is safe
– I have a hard time determining what growth rate to give the company for any target price, hence my difficulty in considering them for the portfolio
– EPS expectations indicate lower and declining numbers that may offer upside to the stock IF they surprise on earnings. But…recent history over the past few quarters is that they have missed & may continue to miss
– Revenues have grown, but EPS has yet to be controlled or grow with some stability/predictability
– I don’t see them as having superior or on par management as my existing exposure to the segment
– There’s always the opportunity that they could be a good defensive play if the economy suffers instability
– My opinion from a technical point would be that you’re paying a lot at a P/E of ~22-24 in comparison with other competitors
– I’m not entirely convinced they can compete aggressively with SC’s strategic push into Quebec. The SC model has shown so far that they can continue to pull market share away from their competitors with relative ease and until that shows some stoppage Jean Coutu may be in for some long-term challenges.
– Eckards was an obvious mistake. I don’t like strategic mistakes because it often indicates to me what control, insight or foresight management may have of the business, market in general or their target consumer. Do what you do best right?

The bottom line is it might offer a contrarian opportunity if you have the cash to burn. I often take those positions in a stock because the market enjoys neglecting some fundamental factor that offers significant value to the valuation of the company. But I don’t see any of that in the company at present and until I see a change in the execution by management, I’ll continue to hold the bigger competitors as exposure to that segment of my portfolio. Rite-Aid I’ve never actually taken a look at, but my feeling is that my holding in Walgreen provides sufficient exposure to US consumers as I concentrate the majority of my portfolio on other segments.