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Fool’s Eye View: Building A Healthy Portfolio

Hospitals are can be a bit like hotels except they don’t leave a piece of chocolate on your pillow at night. That might seem a little facetious. But essentially, hospitals are places where people rent a room or a bed space when they are unwell and check out when they feel better….

…. during their stay, they are cared for by nurses and doctors in exchange for a consideration.

According to Deloitte, global healthcare spending could rise around 5% annually to exceed $10 trillion by 2022. Of course, not every dollar will be spent in hospitals. Other healthcare companies have a vital role to play too. These include pharmaceutical companies such as GlaxoSmithKline (LSE: GSK) in vaccines and Abbott (NYSE: ABT) in diagnostics.

GlaxoSmithKline’s vaccine business generated sales of nearly US$7.5 billion in 2018 by delivering two million vaccine doses per day in 160 countries.

Abbott is notable in diagnostics and medical devices. Every day, more than 10 million tests are run on its diagnostics machines to provide lab results for millions of people. The division generated US$7.5 billion in annual sales.

Healthy demand

Robot surgeons such as Intuitive Surgical (NASDAQ: ISGR) and Singapore Press Holdings (SGX: T39), which has moved into care homes for the elderly, are other examples of players in the industry.

Intuitive’s robotic-assisted systems are used in hospitals in over 60 countries. Meanwhile, SPH’s foray into nursing homes has made it one of Singapore’s largest private nursing-home operators with over 900 beds located around the island.

Healthcare is not just big business it can be a healthy for your portfolio too because the rising demand for healthcare is undeniable.

Firstly, the global population is ageing. For instance, in Japan, adult diaper sales surpassed sales of baby diapers nearly 10 years ago. We have an ageing population.

Many will spend time in hospitals. There is also a greater prevalence of chronic diseases. Additionally, advances in innovative technologies will continue to drive demand for healthcare, with hospitals at the forefront of that growth.

Healthy profits

By and large, hospitals are profitable businesses.

It might take a newly-built hospital a little while to recoup its investment. But the median net income margin for hospitals is around 11%. In other words, they could make $11 of bottom-line profit on every 100 dollars of revenue.

For example, Singapore’s Raffles Medical Group (SGX: BSL) has delivered an average bottom-line margin of about 17% since 2006. What is remarkable is that during this period, which includes the Great Financial Crisis, Raffles Medical did not see any erosion in its profitability….

…. Apparently, hospitals could be largely unaffected by prevailing economic conditions

It might even be said that hospitals are almost recession-proof. But that doesn’t mean that they are immune from competition. Patients, by and large, have choices.

In fact, Singapore, which was once seen as a destination of choice for medical tourism, has experienced fierce competition from neighbouring countries such as Malaysia, Thailand and the Philippines.

Consequently, investors need to pick their investments carefully. And hospitals need to ensure that they use their resources efficiently, if they are to retain the support of investors.

Healthy returns

In the main, hospitals are quite efficient. The median return on equity is around 12.8%. It means that investors can expect hospitals to deliver $12.80 on every $100 that they have invested in the business.

Warren Buffett said: “If you have high enough returns on equity and you can re-invest more capital at attractive rates of return, then the world compounds very fast”. That is why investors should be on the lookout for companies that can deliver attractive returns on shareholder funds.

But it is also important to understand why the returns are high. Not all returns are generated the same way. In the case of hospitals, the high return on equity has been driven primarily by those high net income margins.

They also use the assets at their disposal efficiently. On average, hospitals generate around $65 of sales on every $100 of assets. That is very respectable for asset-heavy businesses.

After all, those magnetic resonance (MR) scanners don’t come cheap. Nor do positron emission tomography (PET) scanner that can cost around $2 million a pop.

Hospitals are also able to generate a high return on equity as a result of their use of leverage. A little leverage is never a bad thing for shareholders. It can mean that the business is using someone else’s money instead of relying solely on shareholder funds.

On average, hospitals have significantly more liabilities than assets that can translate to a leverage multiplier of about 1.5. In other words, returns on equity are boosted 50% through borrowings.

In the main, hospitals look attractive. They have a high return on equity; they use their assets efficiently and they also employ borrowing modestly, which should not imperil their business. What’s more, demand for their services are unlikely to wane. And as we get older, the demand just gets greater.

A version of this article first appeared in the Business Times.

David Kuo owns shares in GSK. The Motley Fool has recommended RMG and Intuitive Surgical The Motley Fool Singapore does not own shares in any of the companies mentioned. All information is provided exclusively by The Motley Fool Singapore Pte Ltd, a licensed investment advisory research provider (MAS Licence No. FA100056-1). Any information, commentary, recommendations or statements of opinion provided here are for general information purposes only.