Analyze the key financial ratios of healthcare stocks

When evaluating a company’s investments, it is important to look at them in the context of their industry. Each department has different attributes that are different from other departments. For example, capital-intensive industries, such as airlines and manufacturing companies, have high debt levels, while Internet companies generally have low debt levels. Comparing them will not be an apple-to-apple comparison. Therefore, compared with other sectors, different ratios are more suitable for analyzing certain sectors.

Some of the key financial ratios that investors and market analysts use to evaluate companies in the healthcare industry include cash flow coverage ratio, debt capitalization ratio, and operating profit margin.

Key points

  • The healthcare industry includes companies in various fields, including hospitals, medical device manufacturers, and pharmaceutical companies.
  • Investors are optimistic about the healthcare industry because they think it is stable and a good defense against economic recession.
  • In terms of growth, the healthcare industry has been one of the best performing industries.
  • Hospitals and medical institutions usually have to wait a long time to obtain reimbursement from insurance companies, so using cash flow ratios to assess the company’s ability to pay debts is a good indicator.
  • Many healthcare companies have high capital expenditures, so analyzing debt capitalization ratios can help determine whether they have enough capital to meet long-term debt.
  • The operating profit margin allows investors to see the amount of profit a company makes from its core business before interest and taxes are deducted.

Overview of the healthcare industry

The healthcare industry is one of the largest market industries, covering various industries such as hospitals, medical equipment manufacturers, and the pharmaceutical industry. The industry is popular with investors for two reasons.

First, many investors believe that it contains a stable industry that can provide good defensiveness to help withstand the general economic or market downturn. Regardless of the financial situation, individuals always need medical care.

In times of economic hardship, hospital and pharmaceutical revenues may decline, but compared with industries such as the retail industry or the automobile industry, overall consumer demand for healthcare services is less affected by economic conditions. Although healthcare stocks may fall in line with the overall bear market, they are generally considered less vulnerable than stocks of companies in many other industries.

The second main reason that healthcare company stocks are attractive to investors is that the industry has always been one of the best performing industries in terms of growth. The two factors driving the continued growth of companies in this industry are the aging population of baby boomers who need continuous health services and the continued development of medical technology and drug disease treatment.

Evaluation Healthcare Unit

Because the healthcare industry is so extensive, investors need to compare similar companies in the same industry in the industry when evaluating equity. Some key ratios can be effectively used in fundamental analysis of almost all healthcare stocks.

Cash flow coverage ratio

Cash flow coverage is a good comprehensive evaluation index, but it is also particularly important for enterprises such as hospitals and medical institutions. Since such companies often need to wait a long time to obtain financial reimbursement from insurance companies or government agencies, having sufficient cash flow and good cash flow management are critical to their financial survival.

Certain pharmaceutical companies may be a risky investment because they spend a lot of money on drug research and development (R&D). If the drug is not approved by the regulatory authorities, the company may suffer significant losses. Pharmaceutical companies that already have many viable drugs on the market are more conservative.

This ratio is calculated by dividing the operating cash flow (a number that can be obtained from the company’s cash flow statement) by the total debt. It reveals the company’s ability to meet its financing obligations. It is also a ratio that potential lenders consider to be particularly important, and therefore will affect the company’s ability to obtain additional financing if necessary. A ratio of 1 is generally considered acceptable, and a ratio higher than 1 is more advantageous.

Debt capitalization ratio

The long-term debt capitalization ratio is an important leverage ratio used to evaluate companies with large capital expenditures and therefore large long-term debts, such as many healthcare companies. This ratio is calculated as long-term debt divided by total available capital. It is a variant of the popular debt-to-equity (D/E) ratio and mainly indicates how high a company’s leverage is relative to its total financial assets. A ratio higher than 1 indicates that the company’s financial situation is unstable and its long-term debt is greater than its total available capital. Analysts prefer to see ratios less than 1 because it indicates that the company’s overall financial risk level is low.

Operating profit margin

Operating profit margin is one of the main profit ratios commonly considered by analysts and investors in equity valuations. A company’s operating profit margin refers to the amount of profit a company obtains from selling products or services after deducting all production and operating expenses, but without considering interest and tax costs.

Operating profit margin is the key to determining the company’s potential earnings, and therefore the key to assessing its growth potential. It is also considered to be the best profitability rate for evaluating a company’s management status, because the management of basic overheads and other operating expenses is critical to the profitability of any company. The operating profit margins of different industries vary greatly, and comparisons should be made between similar companies.

Bottom line

Evaluating a company can be a daunting task because there is a lot of information to dig, and it can be difficult to determine what is particularly relevant to the company at hand. Utilizing common financial ratios used to analyze companies in a particular industry is a great way to understand the fundamentals of the industry and the companies operating in it.

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