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Investing in Medical Services stocks is reflective of a conservative strategy. The sector’s revenue and earnings growth rates are often steady, but rarely spectacular, especially when compared to high-tech medical sectors. Medical Services equities are usually viewed as safe plays and, barring any industry-specific concerns, perform a bit better than the broader market averages. Taking care of their health is a top priority for most people and, when ill, they will seek treatment throughout the economic cycle.

 

The Breakdown . . .

Hospitals are the cornerstone of Medical Services. Government laws mandate that any facility with an emergency room must treat anyone that walks through the door, regardless of insurance coverage or financial standing. Therefore, bad-debt expense is a key factor behind the wide earnings swings a hospital may experience. Specialty hospitals, which do not have emergency rooms, are not subject to such law and focus on accepting well-heeled patients with good insurance plans. These hospitals enjoy fairly predictable revenue streams.

Insurers, most of which are Health Maintenance Organizations, are the entities that foot the bill for medical services. Strong underwriting skills are an important determinant of profitability. Regular policy payments, or the premium, received from a purchasing corporation should more than cover realized medical costs. The Medical Cost Ratio is a crucial measure of the health of an insurer. Successful insurers effectively manage the timing of when medical services are consumed and when the bills are paid.

Clinical laboratories are the final piece of the Medical Services triumvirate. These facilities are the testing centers for diseases and other medical concerns. There are high barriers to entry in this sub-sector, thus competition is limited. Still, the labs are more economically sensitive than hospitals and insurers. In tough times, management may suspend the testing of drugs with a high propensity for abuse. Instead, they will pay attention to more profitable testing for cancer, heart ailments and exotic diseases. Government reimbursements and treatment prices are two factors that need to be monitored by investors.

 

. . . Lowdown . . .

Monitoring federal legislation, particularly bills related to Medicare and Medicaid funding, is a must for the investment community. The U.S. government is the largest buyer of healthcare services. All proposed laws pass through the House Ways and Means Committee. Regardless of whether the committee is under Democratic or Republican control, industry compensation for benefits can fluctuate according to political and economic influences. Government contracts may improve a company’s fortunes, but potential changes to financing create uncertainty. Usually, rates are set in advance so that services companies have time to make necessary operating adjustments. When the government’s budget is under severe strain, revenue and earnings performance suffers.

Members of all three segments of this industry are subject to malpractice and other medical lawsuits. It’s essential to maintain adequate liability reserves. Medical Services companies are, however, less exposed to the enormous legal awards that may be placed against drug purveyors.

Physician retention is another important metric that investors should consider. A high turnover rate is a red flag, possibly indicating poor business management. Care-provider turnover leads to disruptions in patient care. Unhappy customers can result in lost revenue and profits.

Domestic population demographics are working to this industry’s favor. The Baby Boom generation totals some 75 million and is aging. Boomers are now entering a time in their lives when they require more medical services. And technological advances are allowing people to extend their lives, albeit under more medical supervision. Additionally, Baby Boomer or not, people afflicted with chronic or terminal diseases are living longer with better care. Furthermore, with world travel extending into previously undeveloped, underserved areas, exotic diseases are spreading to new locations, even threatening a pandemic. Ahead, revenues are sure to expand, but health expenditures are on the rise and need to be closely managed. 

Cash flow is vital to the success of a Medical Services provider. Hospitals have heavy budgets for physical buildouts and the modernization of equipment and facilities. Labs, as a whole, are spending greater amounts on research and development. Also, Health Maintenance Organizations are competitive and need to maintain rich advertising to hold on to, or boost, market share. For the most part, over its history, the industry has been able to comfortably service its debt, with the exception of public hospitals struggling to care for the uninsured. In years past, companies turned to mergers and acquisitions to gain economies of scale and improve operating performance. Lately, managements have pursued joint ventures, which entail less financial and business risk.

 

. . . And Throw Down

A majority of Medical Services companies have above-average Stock Price Stability. Still, periodically, these companies will suffer setbacks, be it from a stressed economy, government decree, or an internal problem, and share prices will suffer. When such a setback happens, especially to a well-established company, investors can take advantage, purchasing shares and holding them in anticipation of a long-term recovery. Occasionally, new entrants, with unique services, join the industry and present opportunities to aggressive growth investors.