By Paul R. La Monica

Healthcare stocks have been under the weather for the past few years, underperforming the broader market's rally despite surges for obesity drugmakers Eli Lilly and Novo Nordisk. But the sector is off to a healthy start in 2025. Is the worst finally over for Big Pharma, biotechs, insurers, and medical device makers?

CVS Health -- which owns insurer Aetna and pharmacy-benefits manager Caremark, along with its massive drugstore franchise -- is the best-performing stock in the S&P 500 this year, surging nearly 30% as of midday Wednesday. Shares of CVS's struggling rival, Walgreens Boots Alliance, have soared more than 20% as well. Healthcare insurer Humana has risen nearly 20%. And shares of medical equipment companies DaVita, Medtronic, DexCom, Thermo Fisher, and Baxter are all sporting double-digit percentage gains in 2025.

This could be just the beginning. Many leading healthcare stocks are still playing catch-up to the broader market. The Health Care Select Sector SPDR exchange-traded fund is trading for less than 18 times earnings estimates for this year, a 20% discount to the S&P 500's price-to-earnings ratio of more than 22. The sector typically trades for only about 13% below the broader market's multiple, according to FactSet.

"The healthcare sector is cheap. It's hated," said Sandy Villere III, a portfolio manager with Villere & Co. But that's good news for bargain hunters looking for values, he said. Another plus: "You still get good yields," with many healthcare stocks paying dividends north of 1.5%, he added.

Villere said his firm is making a broad bet on the sector, with positions in Big Pharma/medical equipment company Abbott Laboratories; infusion services firm Option Care; biotech Ligand Pharmaceuticals; medical device maker Teleflex; and Idexx Laboratories, which develops diagnostic and testing products for veterinarians.

Earnings are expected to grow at a solid clip for the entire sector this year and next as well, following a big drop in 2023 and only about a 5% rebound last year. Analysts are forecasting a 20% increase for the sector's earnings in 2025 and another 10% gain in 2026.

It also appears that investors are slightly less worried about the possibility of massive changes to the sector coming from Washington.

Yes, Robert F. Kennedy, Jr. remains a worry for vaccine makers, but his confirmation as Health and Human Services secretary is far from certain. There are also lingering concerns about bipartisan legislation from Senators Elizabeth Warren and Josh Hawley that seeks to rein in the power of healthcare companies that own the big pharmacy-benefit managers, namely CVS, UnitedHealth and Cigna.

Investors should ignore the political noise. Michael Arone, chief investment strategist for State Street's SPDR Business, is predicting that healthcare stocks will beat the S&P 500 this year, saying that the sector is "ripe for an upside performance surprise."

Arone noted that the health care sector has outperformed the broader market in the first year of every Republican administration since President Ronald Reagan's inaugural year in 1981. In addition, the healthcare sector's weighting in the S&P 500 is now flirting with a 25-year low, he said.

Janus Henderson portfolio managers Andy Acker and Dan Lyons also think the market is overly fearful about potential disruption from the White House and Congress.

"There's also a tendency for healthcare stocks to assume the worst about potential policy reform, selling off before details -- often more nuanced than they first appear -- become clear. We think today is no exception," Acker and Lyons said in a report Wednesday.

The duo added that RFK Jr., if confirmed, won't be the only one calling the shots on healthcare policy in Washington. They noted that Kennedy would likely have little power over changes at the Food and Drug Administration and wrote that "President Donald Trump's nominee for FDA commissioner, Dr. Martin Makary, a well-respected physician, could be a counterbalancing force."

So at the end of the day, investors should focus on how cheap the sector is. Ackers and Lyons said healthcare stocks are "deeply undervalued."

"The selling is overdone, with the market not fully appreciating the acceleration of innovation in healthcare and overreacting to near-term headwinds," they wrote. "The sector could be set up for strong future returns."

Write to Paul R. La Monica at paul.lamonica@barrons.com

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January 29, 2025 13:27 ET (18:27 GMT)

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