Tag Archives: management

Consider Adding Health Care To Your Winning Allocation: And The ETF To Do It

Summary Supplementing your core ETF portfolio with smart sector bets can lead to healthy returns. Powerful demographic and related trends make health care one such sector, and now may be a good time to get in. However, there are risks. A quality ETF can help to mitigate these. I share my suggestion as to the one you should choose. When building your ETF portfolio, it is good to start with the basics. In my previous work on Seeking Alpha, I have suggested a simple, yet powerful and globally-diversified portfolio based on just 3 ETFs . However, you may wish to enhance such a basic approach by supplementing it with ETFs targeted at certain sectors of the marketplace. REITs are one such possibility. In a follow-up article , I built a four-ETF variant of the base portfolio that includes REITS. For this article, however, let’s take a look at another sector in which you may want to make a targeted investment. I will also suggest that you use a specific ETF to do so. Why Health Care? Why Use an ETF? In my personal portfolio, I have chosen to add a targeted investment in the health care sector. Why? Please allow me to share just a couple of quick items I found when researching this topic. We have an aging population. Consider the following, from the Administration on Aging , part of the U.S. Department of Health and Human Services: The older population-persons 65 years or older-numbered 44.7 million in 2013 (the latest year for which data is available). They represented 14.1% of the U.S. population, about one in every seven Americans. By 2060, there will be about 98 million older persons, more than twice their number in 2013. People 65+ represented 14.1% of the population in the year 2013 but are expected to grow to be 21.7% of the population by 2040. Not surprisingly, with an aging population comes increased costs for health care. Consider two excerpts from a report on aging from the Centers For Disease Control : The increased number of persons aged > 65 years will potentially lead to increased health-care costs. The health-care cost per capita for persons aged > 65 years in the United States and other developed countries is three to five times greater than the cost for persons aged 65 years ($12,100), but other developed countries also spent substantial amounts per person aged > 65 years, ranging from approximately $3,600 in the United Kingdom to approximately $6,800 in Canada ( 13 ). However, the extent of spending increases will depend on other factors in addition to aging ( 12 ). The median age of the world’s population is increasing because of a decline in fertility and a 20-year increase in the average life span during the second half of the 20th century ( 1 ). These factors, combined with elevated fertility in many countries during the 2 decades after World War II (i.e., the “Baby Boom”), will result in increased numbers of persons aged > 65 years during 2010–2030 ( 2 ). Worldwide, the average life span is expected to extend another 10 years by 2050 ( 1 ). The growing number of older adults increases demands on the public health system and on medical and social services. Chronic diseases, which affect older adults disproportionately, contribute to disability, diminish quality of life, and increased health- and long-term-care costs. In summary, the reports reveal that, due to longer life spans, people often live longer with chronic disease. Sadly, factors such as obesity and diabetes, more and more common in our culture, also lead to greater need for medications and other health care support. Finally, technological advances are making possible the treatment of certain conditions that simply could not have been treated in the past Certainly, factors such as these bode well for the long-term outlook for health-care related products and services. At the same time, investment in the health care sector is not without its risks. For example, pharmaceutical companies must spend vast amounts on R&D to develop and bring new drugs to market. But getting a drug to market is no small task. To begin with, it is a real challenge to identify and develop new chemical compounds for such drugs. And even once a potential drug is developed, it must go through rigorous clinical trials before it is approved for sale to the public. Needless to say, not all drugs make it through this process. This is where the ability to use an ETF to invest in health care can be, well, good for your investment health. I will get into the specifics of our focus ETF as it relates to this matter in just a little bit. Why Now? I have been hoping to write an article on this topic for some time. Why did I choose to do so now? The impetus actually came from this news item right here on Seeking Alpha. I won’t bother recapping it; it is short and you can read it for yourself. But here is a picture that will make very evident what the quoted analyst was getting at. VHT data by YCharts The blue line represents the Vanguard Health Care ETF (NYSEARCA: VHT ), the focus of our article. The yellow line represents the broader S&P 500 index. As can be seen, there was a roughly 12% gap between the performance of this index and the S&P 500 just a little earlier this year. Due in large part to recent concerns having to do with the biotech sector, that YTD gap has narrowed to a mere 1.2%. As the quoted analyst suggests, this may offer a good opportunity to either enter, or add to your position in, this sector. The Power of VHT Earlier, I briefly touched on some of the risks involved in investing in the health care sector and suggested using an ETF to mitigate such risk. Simply put, this is because a well-chosen ETF will allow you to remain well diversified, thus lessening single-company risk. As alluded to earlier, in this article I chose to focus on the Vanguard Health Care ETF. This ETF is based on the MCSI US Investable Market Health Care 25/50 Index . Let’s start with a closer look at that index, in the below picture taken from the factsheet for the index. (click to enlarge) Here are a few things worthy of note: There are 349 constituents, or companies, in the index. The Top-10 holdings comprise some 44.96% of the overall index, and are mostly large-cap pharmaceutical companies. This is also reflected in the overall 36.58% weighting of pharmaceuticals in the index (see pie chart). However, this risk is somewhat balanced by the inclusion of McKesson Corp. (NYSE: MCK ) and similar companies involved in the distribution of health care products, and UnitedHealth Group (NYSE: UNH ) and similar companies involved in healthcare services. This diversifies your risk, as the pie chart shows, across various sub-industries within the overall health sector. If you look at the Portfolio and Management tab of the factsheet for VHT, you will notice that this ETF is extremely faithful in tracking this index. Vanguard supplements this with a rock-bottom expense ratio of .12%. The fund’s total net assets of $6.1 billion and average daily trading volume of $58.37 million mean that the fund is extremely liquid, leading to a low .07% trading spread (the average difference between “buy” and “sell” transactions). I would hope you hold this ETF for the long term, but the above figures will hold you in good stead should you need to trade. Finally, VHT carries a 1.45% distribution yield, which Vanguard recently shifted from being an annual distribution to a quarterly distribution, which I really love. Summary and Conclusion I believe health care is a great sector in which to make a targeted investment. In this article, I have recommended using an ETF to do so, and featured the Vanguard Health Care ETF as what I believe to be your best tool to do so. This excellent choice gives you tremendous diversity across the sector, coupled with a low expense ratio and great liquidity. Happy investing!

The Two Definitions Of Net-Nets: Net-Net Working Capital Versus Net Current Asset Value

Summary There are two definitions of net-nets: Buying stocks at below two-thirds of net current asset values (NCAV), and purchasing stocks trading under net-net working capital, a revalued version of NCAV. I offer some general principles and caveats that apply in the case of both low P/NCAV net-nets and low P/NNWC net-nets. My exclusive research service, Asia/U.S. Deep-Value Wide-Moat Stocks, provides watchlists and profiles of net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts. Defining Net-Nets Two different “versions” of net-nets have evolved from the teachings of Benjamin Graham in his two books “Security Analysis” and “The Intelligent Investor.” The first definition of net-nets involves comparing the net current asset values (current assets – total liabilities) (NCAV) per share of stocks against their share prices and buying them if the P/NCAV ratios are below two-thirds. The second definition of net-nets, more commonly known as net-net working capital (NNWC), makes an attempt at “revaluing” NCAV with the following adjustments: +100% of cash and short-term investments +75% of accounts receivables +50% of inventories -100% of all liabilities Both definitions of net-nets try to incorporate a margin of safety for the collectability risk of accounts receivables and the salability of inventories to a certain extent (the former through an arbitrary discount assigned to the net current asset value; the latter via specific discounts for accounts receivables and inventories). Most deep value net-net investors tend to use the first definition of net-nets, P/NCAV, in their search for potential investment candidates, as the screening for low P/NNWC stocks is more difficult in reality (compared with low P/NCAV stocks). Firstly, there is a greater likelihood of data services providers getting the calculation of accounts receivables wrong since a significant number of companies tend to lump accounts receivables and other receivables and may not provide the necessary disclosure to differentiate between them. If one incorporates all receivables (including non-operating receivables) in the calculation of low P/NNWC net-nets, he or she may be overstating the value of NNWC. Secondly, simply taking 100% of cash and short-term investments at their face values may not be the wisest thing to do since the market values of short-term investments will fluctuate and not all cash are unencumbered and excess in nature. Thirdly, the 25% and 50% discounts assigned to accounts receivables and inventories respectively may not be appropriate for all companies. For example, some companies may have customers which are MNCs or government-linked where the probability (and history) of defaults is close to zero, so even a 25% discount for accounts receivables is considered harsh. On the other hand, for companies which sell products with short lifecycles and shelf lives and are witnessing growing inventory days, a 50% discount for inventories may be simply too little. The second definition of net-nets, buying at less than two-thirds of NCAV tries to solve this problem by assigning a blanket 33% discount to all the current assets on the balance sheet. Stocks Trading At Low P/NCAV But High P/NNWC Continuing from the discussion above, it will be intuitive to conclude that stocks trading at low P/NCAV ratios but high P/NNWC are likely to have lower margins of safety since the “quality and quantity” of assets are questionable. I provide two examples of such stocks for illustrative purposes below. I focus on assessing the margin of safety for the stock (comparing net current asset value against net-net working capital) rather than the stock’s investability as a net-net. STR Holdings (NYSE: STRI ), a provider of encapsulants to the photovoltaic module industry, appears on the net current asset value screen as a net-net trading at 0.32 times P/NCAV, but it will not qualify as a net-net if one considers its P/NNWC ratio of 1.5. This is because STRI’s current assets include income tax receivable and other current assets amounting to $8.3 million and $4.7 million respectively, which I do not include in the calculation of NNWC. Hong Kong-listed Xinjiang Tianye Water Saving Irrigation System Co. ( OTC:XJGTF ) (840 HK), a company engaged in the design, manufacturing and sales of drip films, PVC/PE pipelines and drip assemblies used in water saving irrigation system, is valued by the market at a P/NCAV of 0.64 times, but its P/NNWC ratio exceeds 2 times. This is largely due to the fact that inventories and accounts receivable contribute 63% and of 16% of Xinjiang Tianye Water’s current assets respectively and are therefore heavily discounted based on the net-net working capital formulae. The full list of 75 U.S. and Asian low P/NCAV (less than 1) net-nets trading at high P/NNWC (greater than 1) ratios, which should warrant greater attention to their underlying asset values, is available exclusively for subscribers of my Asia/U.S. Deep-Value Wide-Moat Stocks exclusive research service in a separate bonus watchlist article. Assessing The Real Margin Of Safety For Net-Nets There are some general principles and caveats that apply in the assessment of the margins of safety for both low P/NCAV net-nets and low P/NNWC net-nets. One of them is the collectability risks relating to accounts receivables. Accounts receivables are near-cash in nature as long as they do not become bad debts i.e. customers default on payment. One can assess the collectability risk of accounts receivables for a specific stock in terms of the trend in accounts receivable days, the credit payment terms for customers, the credit strength of major customers, the adequacy of current provisions for bad debts and the potential for further write-downs on the receivables. Another point to take note of is the salability risk of inventories. Under normal conditions, the costs and selling prices of inventories are relatively stable. In reality, rising raw material costs, changing customer preferences and lack of bargaining power with suppliers and customers could lead to overstocking, loss-making finished products, and eventually write-downs on inventories. Similarly, cash and short-term investments are not always as “safe” as they appear to be. The accounting values of short-term investments such as stocks, bonds, hybrid securities, structured products are typically mark-to-market with huge volatility in their prices and values. In addition, not all of a company’s cash balances are unencumbered and excess in nature since some cash may be set aside for security deposits or working capital purposes. Also, if a net-net is loss-making, the market may be discounting the future cash burn into its share price. For readers interested in learning more about the background of net-nets and specific Asian names, they can refer to my articles on Hong Kong net-nets and Japanese net-nets here and here respectively. Note: Subscribers to my Asia/U.S. Deep-Value Wide-Moat Stocks get full access to the watchlists, profiles and idea write-ups of deep-value investment candidates and value traps, which include net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.