A Checkup On A Big Healthcare ETF

Last year, the Health Care SPDR (ETF) XLV gained 6.8 percent, which was good for the third-best performance among the nine legacy sector SPDR exchange-traded funds. XLV's 2015 showing, though off the pace set in previous years, was still sturdy when considering the punishment incurred by biotechnology stocks in the back half of the year.

XLV is struggling out of the gate in 2016. The largest healthcare ETF by assets entered Thursday with an 8.3 percent year-to-date gain, making it the second-worst performer among the established sector SPDRs to start the New Year.

With that lethargic start to 2016, perhaps it is not surprising that some analysts have a tepid view of XLV. For example, AltaVista Research rates the healthcare ETF Neutral, a rating that “indicates that valuations adequately reflect the fundamentals of stocks in these funds. The majority of funds we cover fall into this category,” said the research firm in a new note.

Not all investors are throwing in the towel on XLV, as highlighted by the ETF's 1 percent increase in shares outstanding over the past month. That is good for the fourth-best showing among the sector SPDR ETFs, according to AltaVista data.

Related Link: Looking To Healthcare ETFs For Earnings Growth

Taking XLV's Vitals

The $12.7 billion XLV allocates a combined 24.5 percent of its weight to Dow components Johnson & Johnson JNJ, Pfizer Inc. PFE and Merck & Co., Inc. MRK. However, biotechnology looms large in XLV, as the ETF's second-largest industry allocation at 23.3 percent.

Over the past five years, the healthcare sector, the third-largest sector weight in the S&P 500, has handily outperformed the S&P 1500 Composite Index, delivering better than double the returns of that broader equity benchmark. Driven in large part by the biotechnology boom, XLV and rival healthcare ETFs have been among the best-performing funds at the sector level, but the sector is fraught with risk this year.

2016's Risks To The Healthcare Sector

Currently, 28 percent of XLV's shares outstanding are on loan to short sellers, good for the fourth-highest total among the sector SPDR ETFs. Based on 2016 estimates, AltaVista forecasts a price-to-earnings ratio of 14.1 for XLV and a price-to-cash flow ratio of 11.8. Those forecasts for the S&P 500 are 15.4 and 10.8, respectively.

“Until the recent decline in biotech shares dragged the sector's overall P/E down, investors had been revaluing Health Care stocks with steadily higher multiples since late 2011. Yet the exceptionally high and steady profitability on which that revaluation was based remains intact. Post-decline, the sector is trading at a P/E discount to the broader S&P 500, whereas historically it has enjoyed a premium, making shares appear relatively attractive,” said AltaVista.