Your perspective on our increased longevity may be impacted by the current state of your 401(k) balance. But there’s no getting around the fact that 85 is definitely looking like the new 65: Half of today’s 65 year olds will still be alive into their mid 80s. For married couples age 65 today, there’s a 45% chance one spouse will still be alive past age 90.
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With the prospect of a longer life comes the prospect of more aches and pains. And that in turn suggests aging Boomers are going to be getting more medical tests done in the coming years. Clyde McGregor, co-portfolio manager of the $19 billion Oakmark Equity & Income fund cites this “demographic tailwind” as a compelling catalyst going forward. Oakmark is a bottoms-up stock-by-stock, “I want it at a steep discount to intrinsic value,” shop. But in a recent interview with Value Investor Insight, McGregor says that the prices the fund has paid for a variety of healthcare companies has provided that potentially powerful demographic tailwind “more or less for free.” Quest Diagnostics (DGX) and Laboratory Corporation of America (LH) are two aging-boomer investments in the Oakmark E&I portfolio. Quest Diagnostics was added to the portfolio in mid 2011, LabCorp first appeared in 2008. The firms are #1 and #2 national providers of out-patient testing that ranges from basic cholesterol reads to advanced “esoteric” tests.
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Like much of health care, the two biggest national med-testing firms were held back by the swirling uncertainty about the fate of the Affordable Care Act. But in the wake of the Supreme Court clearing up that cloud last summer, both companies have continued to struggle, running counter to the health care sector and the overall market, as seen in a stock chart.
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The problem it seems is that we’ve all been holding back on the doctor’s visits ever since the recession hit; deductibles and co-pays are not easily digested on crimped household cash flow. Revenue growth has been tepid for both companies; Quest has eked out an 0.63% gain over the trailing 12 months, and LabCorp is down 0.63%. Yet despite that slow top-line performance, Quest Diagnostics’ profit margins has widened over the trailing 12 months, as has LabCorp’s profit margins.
If you’re on board with the “demographic tailwind” argument, recent sluggishness becomes a lull, not a permanent slowdown. And YCharts has in the past extolled the growing market share and operations of thee two companies.
Another potential catalyst arrives next year when the ACA act kicks in, insuring millions more of us. One of the provisions of the new law is that insurance in most instances must cover basic preventive checkups at no additional cost/co-pay to the insured. If that pushes more of us to get a checkup, it stands to reason, some of that increased patient-visit volume will result in more testing.
Sure, that’s next year. And the aging-boomer catalyst is going to play out over an even longer time span. But if you’ve got a little bit of patience and investing foresight, these stocks have compelling entry points today. Morningstar has a proprietary “fair value” estimate of stocks it covers. Right now, the overall health care sector trades at 97% of fair value, according to Morningstar. The diagnostics and research subset trades at 88%.
While Quest Diagnostics has seen its earnings per share jump more than 100% over the past five years, and LabCorp’s earnings grew nearly 50%, they haven’t seen any pick up in their overall valuation, measured by PE ratio:
And operationally both are looking plenty healthy coming out of a challenging period. Quest Diagnostics has managed to boost its free cash flow by 38% over the past five years, and LabCorp has increased the same metric 30%.
Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at email@example.com.