Which ASX healthcare shares should you own?

The healthcare sector has been one of the best performing sectors on the ASX for a long time, and in fact, over the last five years has outperformed the S&P/ASX 200 (Index: ^AXJO) (ASX:XJO) by a whopping 115%.

Source: Google Finance

Source: Google Finance

The industry has a number of attractive tailwinds behind it including a globally ageing population, advances in technology and access to a fast growing middle class.

Although the Australian dollar has strengthened over the past couple of months, the broader depreciation of the Australian dollar since 2014 has also generally been a nice tailwind for Australian healthcare companies with a global presence.

But not every healthcare company on the ASX has enjoyed great success.

The table below highlights the one year, five-year and ten-year returns of some healthcare stocks on the ASX. The figures are provided by CommSec and include both dividends and capital gains/losses over each period.

 Stock ASX Code 1-Yr Return 5-Yr Return  10-Yr Return
 CSL Limited ASX: CSL  17.1% 27.4% 20.7%
 Ramsay Health Care Limited ASX: RHC  3.4% 31.3% 22.7%
 ResMed Inc. (CHESS) ASX: RMD  -2.6% 22.8% 10.9%
 Sirtex Medical Limited ASX: SRX  42.4%  42.6% 27.3%
Primary Health Care Limited ASX: PRY -24.4% 4.6% -4.6%
Sonic Healthcare Limited ASX: SHL 2.6% 14.0% 7.0%
Mesoblast limited ASX: MSB -30.3% -21.0% 5.1%

It’s pretty clear to see from this basic comparison that not every healthcare company will be a great long-term investment.

Buy why is there such a large discrepancy?

At the end of the day it comes down to earnings and the consistency of those earnings.

Primary Health Care has been one of the worst performing healthcare stocks because its earnings per share (EPS) are the same today as they were around 10 years ago. There is no doubt the company has some attractive assets but unfortunately it has only been able to generate a mid-single digit return on these assets. Add to this a highly leveraged balance sheet and skinny operating margins and it is not difficult to see why it has underperformed.

Mesoblast is another example of an underperforming stock in the sector but for totally different reasons to Primary Health Care. The company is still seen as a speculative company despite boasting a market capitalisation of $950 million. Admittedly, the company has some very promising stem cell therapies that are close to commercialisation, but the company is still cash flow negative and yet to turn a profit. As a result, the share price is highly dependent on sentiment and the continual release of positive news.

Take on the other hand CSL and Ramsay Health Care, which are two of the best performing shares on the ASX over the past decade. Ramsay Health Care has delivered an EPS compound annual growth rate (CAGR) of 16.8% over the last 17 years, while since listing in 1994, CSL has delivered a 24% CAGR in net profit. It’s not hard to see why both companies have delivered double-digit returns for shareholders over a long period of time.

Foolish takeaway

Just because a company is listed in the healthcare sector does not mean it will automatically be a great long-term investment.

Investors should look for companies that are consistently increasing earnings as this is what will ultimately drive the share price and dividends higher over time.

Personally, I think Sirtex Medical is the company that offers the best balance between value and growth right now. The shares are more volatile than your typical healthcare stock but they also offer the potential for higher returns.

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Motley Fool contributor Christopher Georges owns shares in Sirtex Medical. 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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