Healthcare Stocks Are Bargains Now

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Things have to be smoking hot in the stock market for a fund with a 23% one-year return to be considered an underperformer. But that's where we find Fidelity Select Health Care (FSPHX), which in absolute returns had a bonny year but lagged the 38% gain in the S&P 500 Index.

Its peers (health-focused stock funds) also did better, albeit only a bit, with an average 26% gain. Select Health Care is a member of the Kiplinger 25, our list of favorite mutual funds.

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Investors have been focused on stocks that will benefit from the economic recovery, and that typically doesn't include healthcare shares.

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Plus, large-company pharmaceutical firms, which make up 35% of the sector, have not performed well because of uncertainty about expiring patents, says Select Health Care manager Eddie Yoon. "The healthcare sector doesn't sit squarely in the broader narrative of what's going on with the reopening of the economy," he says.

Healthcare stocks rarely dominate in any given year. Outside of the occasional headline-making breakthrough, they tend to chug along, increasing earnings year over year but not winning much attention. A lack of enthusiasm for the sector is creating opportunity.

In the Bargain Bin

Healthcare shares are about as cheap as they have been in 40 years. Yet long-term demand and expectations for earnings growth are strong. Plus, the sector is going through an "enormous amount of innovation," says Yoon.

Yoon has been manager since 2008. He and a dozen analysts with subindustry expertise pick the stocks.

Established firms with stable earnings carry the biggest weights; smaller firms with bigger growth opportunities but more unknowns get smaller weights.

Insurer UnitedHealth Group (UNH), diagnostics and research company Danaher (DHR) and biotech firm Regeneron Pharmaceuticals (REGN) are big fund holdings.

Small firms include two that Yoon held before they went public: Stock in Alignment Healthcare (ALHC), a Medicare Advantage insurer, is up 35% since it debuted in March; Oak Street Health (OSH), which operates primary care Medicare clinics, has gained 51% since going public last August.

Over the past decade, Select Health Care easily trounced its peer group and the S&P 500, with an annualized 17.9% gain.

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Nellie joined Kiplinger in August 2011 after a seven-year stint in Hong Kong. There, she worked for the Wall Street Journal Asia, where as lifestyle editor, she launched and edited Scene Asia, an online guide to food, wine, entertainment and the arts in Asia. Prior to that, she was an editor at Weekend Journal, the Friday lifestyle section of the Wall Street Journal Asia. Kiplinger isn't Nellie's first foray into personal finance: She has also worked at SmartMoney (rising from fact-checker to senior writer), and she was a senior editor at Money.