The one big risk to healthcare stocks that investors are facing

Reforms to the healthcare system could have big impacts on Sonic Healthcare Limited (ASX:SHL), Medibank Private Ltd (ASX:MPL), and NIB Holdings Limited (ASX:NHF).

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People buy stocks for lots of reasons, but those chasing healthcare stocks usually want several things: recurring, defensive earnings, ideally buoyed by an ageing population and tasty dividends.

It’s a sound strategy that has served many investors well over the years, but be warned: Not all healthcare stocks are as defensive as you think they are.

With a great portion of Australia’s healthcare system subsidised and/or otherwise regulated by the Australian government, investors often overlook one major risk:

Government Regulation

This particularly applies to companies like Medibank Private Ltd (ASX: MPL) and NIB Holdings Limited (ASX: NHF) which operate in a controlled market – in fact, the government decides when and how much health insurers can raise their premiums by.

Other companies like Sonic Healthcare Limited (ASX: SHL) and Capitol Health Ltd (ASX: CAJ) are also at risk, since many of the diagnostic screenings conducted by these companies are free to users – wholly subsidised by the government.

During normal times this isn’t a problem – the healthcare system is a ‘if it ain’t broke, don’t fix it’ situation if ever there was one – but with the Abbott government trying to stretch its dollars further, investors should prepare for change.

A report released by the Productivity Commission yesterday found that: ‘Governments and patients spend a considerable amount of money on health interventions that are irrelevant, duplicative or excessive; provide very low or no benefits; or, in some cases, cause harm.’

Maybe the $5 GP co-payment won’t go ahead, but with a number of immediate ‘no regret’ fixes available for the healthcare system, it’s virtually certain that there will be changes.

A number of longer-term solutions – like reviewing treatments on the Medical Benefits Scheme (MBS) and Pharmaceutical Benefits Scheme (PBS) for cost-effectiveness – are possible as well, but it is difficult to evaluate how widespread their impact could be.

(Note: You can find the full coverage of the Productivity Commission’s findings in my earlier article here)

Healthcare stocks remain a great way to grow your wealth in the long term, but with changes pending, investors should take extra care to do their research before buying into stocks that might look cheap.

It was Warren Buffett who first popularised the saying ‘price is what you pay, value is what you get’ and that old axiom is still the perfect way to approach health stocks – or any stock, for that matter.

Pay a good price for a great business, and let the magic of compounding take you away.

If it’s good enough for Warren Buffett – and by that I mean if it’s good enough to turn $1,000 into $7 million – it’s good enough for you!

Find out more about the ‘Oracle of Omaha’s investing strategy in The Motley Fool’s special report – simply click on the link below, enter your email address, and we’ll send it to you – FREE!

Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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