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The little known way to crush the ASX in 2016

Credit: Brogan & Partners

It’s important to keep investing simple.

Last year I noted that a ridiculously simple way to smash the ASX200 was to add exposure to the big healthcare companies which make up the S&P/ASX 200 Health Care Index (INDEXASX: XHJ).

It seemed like a compelling argument:

Healthcare stocks are not only growing at unparalleled rates and earning huge margins, but big companies like ResMed, CSL and Cochlear also have strong globally diversified earnings. This lowers geographic risk and amplifies returns from major currencies which are currently smoking the Aussie dollar.”

Almost a year on and healthcare is still trumping the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO):

160504 RP - ASX XHJ 12 months

Source: Google Finance

Australia has a range of strong performing, global healthcare companies. And while some smaller, local companies have stumbled over business models reliant on milking government programs and rebates, the big, geographically diverse companies have thrived.

Paying the premium

With a projected price-to-earnings ratio of 22, the healthcare index still looks expensive relative to the S&P/ASX 200 on 16.5. However many of these companies are in a prime position to compound capital for investors in years to come.

Not only are they selling into a consistently growing industry, but the huge product margins and subsequent high returns on equity being generated mean the companies can keep reinvesting and compounding their growth.

In 2015 for example Fisher & Paykel Healthcare Corp Ltd (ASX: FPH) produced return on equity of 24%. This represents the return on shareholder ownership in the business, and with a debt-to-equity ratio of just 42%, we can be confident that the high return wasn’t simply the result of piling on debt to fund the business.

CSL Limited (ASX: CSL) and Cochlear Limited (ASX: COH) also have high relative returns on equity, but slightly higher debt positions.

Foolish takeaway

Given how long the healthcare story has to play out, and that the high returns-on-equity these companies are producing in general look sustainable, it’s reasonable to expect the healthcare index to continue to perform strongly. Diversifying across different companies will help to reduce company specific risk which can cause havoc, if a product recall is necessary for example.

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Motley Fool contributor Regan Pearson 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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