McMurtry Investment Report & Model Portfolios

McMurtry Investment Report – February 2023

February 2023 – HealthCare Sector- Current Earnings Outlook and Market Valuations

The Canada healthcare sector is totally dominated by cannabis stocks which I do not like. I would only focus your investments in healthcare in the US. Currently the healthcare sector represents 14.7% of the S&P 500 index. Domestically this sector only represents 0.4% of the TSX Composite index.

In the US there are two ETF’s dedicated to healthcare. Invesco’s equal weighted RYH ETF provides broad exposure to all companies, while the market capped weighted iShares IYH offers exposure that is tilted to the larger companies. Over the last one year on a total return basis, both of these ETF’s have outperformed the S&P 500 index by a very wide margin. Healthcare stocks are considered defensive in nature and are not nearly as affected by either rising rates or economic slowdowns. However, over the last month, the benchmark S&P 500 index has begun to outperform the healthcare sector once again with the expectation that both inflation and interest rates are in the process of peaking.

The US healthcare sector is divided up into different sub sectors, namely big pharma / biotechnology, medical devices, hospital management and insurance and lastly drugstores. Each subsector has unique characteristics that makes them perform quite differently from each other.

The big pharma and biotechnology sub sector is affected by the outlook for both current and new diseases. Large sums of money are spent developing new drugs and this involves a great deal of risk on behalf of the companies involved. This is why they require a long patent life to be able to market these new drugs without having their competitors breathing down their necks. Once a drug goes off patent, any competitor can produce a generic version of the same drug without any upfront R&D costs.

Over the last several years, large drug companies like Pfizer and Moderna spent a lot of money developing medications and vaccinations to combat the onslaught of Covid-19. Now that Covid-19 is waning throughout most of the world with the exception of China, the companies need to develop a pipeline of new drugs to combat the growth in cancer, obesity, alzheimer’s, diabetes, parkinson’s, cystic fibrosis and many others.

Vertex is a leading producer of drugs to fight cystic fibrosis and has a very large global market share. Novo Nordisk has a large market share in both diabetes medications and obesity, while Eli Lilly has both new and existing drugs in both diabetes, obesity and alzheimer’s.

Medical device companies include Abbott, Johnson and Johnson, Stryker, Medtronic and Becton Dickinson. Johnson and Johnson also has a consumer products division producing meds like Tylenol. Companies such as Stryker and Medtronic saw their sales of heart stents and knee replacement devices ease off considerably during Covid. These companies are only starting to see the improvement from more surgical procedures now happening.

Medical insurance represents a large area in the healthcare sector with large companies like United Healthcare and Elevance offering a much more comprehensive and extensive coverage than basic Medicare does in the US.

Lastly, CVS in particular started out a as pure drugstore company but has branched out into a fully integrated healthcare provider with its ownership of a pharmacy benefit manager and its recent acquisition over the last few years of Aetna, a major provider of health insurance to individuals.

Currently in my model portfolios I own Merck, Pfizer, Vertex, Astra Zeneca, CVS, Humana and Elevance. As you can see from the attached table, Merck, Pfizer and Abbott are seeing either a large drop in EPS this year or very little growth. Several others are experiencing similar trends. Please note that for companies with a negative year over year growth in EPS for 2023, the PEG ratio cannot be calculated. In regards to my current holdings, I have decided to delete Pfizer from both portfolios. Pfizer is currently transitioning away from its focus on vaccinations for Covid-19 and will need to increase its pipeline of new drugs accordingly. I continue to like the remaining companies in my models. While Merck had a very strong year last year, its long -term growth prospects remain solid. I have also provided stats on many other companies in this sector that are not currently in my model portfolios. Novo Nordisk, NVO – US, looks relatively interesting with a very low forward PEG ratio. This is totally a result of the high projected growth rate in EPS this year of 35% plus. This growth rate is a consensus estimate and not based on corporate management. The actual management of the company projects a much more conservative growth in operating profit this year between 13-19%, about half what the consensus estimate is currently. Taking into consideration that there is a sharp increase in competition from Eli Lilly in the diabetes and obesity areas and that the company is so hesitant to increase EPS growth rates to what the consensus estimates are currently, I have decided not to add Novo Nordisk at this time. The forward PE is still a relatively high 28.38 times and only lower than Eli Lilly’s 39.76 PE on my attached list.


Taking into account the expectation of a peaking in interest rates and inflation combined with the lower probability of a major recession this year with the strong employment growth, I have decided to reduce the sector overweight for healthcare and have gone back down again to market weight my North American benchmark weight of 6.12%. Other less defensive equity sectors like Industrials and Consumer Discretionary are starting to outperform the defensive ones like healthcare.

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