Is there a bubble in healthcare shares like Cochlear Limited? 

It is being reported in the Australian Financial Review (AFR) that Watermark Funds Management (Sydney) is taking net short positions against the healthcare sector believing the sector has entered bubble territory.

It is particularly concerned about healthcare stocks with exposure to the US market as funding providers try to rein in costs. So far Australian stocks affected have failed to reflect this in their price unlike their US counterparts. Watermark has estimated that the Australian healthcare sector is up to 65% overpriced compared to its US equivalents.



Interestingly other fund managers interviewed by the AFR were of a different mindset, believing that although Australia’s healthcare companies are expensive they are of a high quality and deserve to trade at a premium.

So who should we believe?

Personally it is hard to argue that the Australian healthcare sector is not expensive compared to the rest of the ASX. The S&P/ASX 200 Health Care Index has grown 18% over the last 12 months compared to the S&P/ASX 200 which is down 2%.

Does this mean the healthcare sector is in bubble territory?

Again this is not a simple question, while it is true Australian healthcare giants such as CSL Limited (ASX: CSL) and Cochlear Limited (ASX: COH) are indeed at all-time highs, both continue to trade very profitably. As an example, while Cochlear is sitting on a price to earnings ratio of around 40, it is forecasting a profit increase for the current financial year of around 30%. This profit forecast was made assuming an exchange rate of 74US cents. If we consider the Australian dollar is already at 72US cents and likely to head lower particularly if the US Federal reserve raises interest rates as predicted in June, then Cochlear’s value does not seem as stretched as it may first appear.

Foolish takeaway

While it is interesting to hear the thoughts of various fund managers, their powers of prediction are no better or worse than normal investors. It is also wise to cast a sceptical view on the motives behind making a position known to the market. You only need to cast your mind back 6 months to find the Royal Bank of Scotland was advising its clients to sell everything and warning of a “cataclysmic year”. We might wonder how its clients are feeling about that advice now.

Discover the 'new breed' of blue chips that could take your portfolio higher in 2016

These 3 "new breed" top blue chips for 2016 pay fully franked dividends and offer the very real prospect of significant capital appreciation. Click here to learn more.

The report is free! No credit card required.

Motley Fool contributor Alan Edmunds owns shares of Cochlear Ltd. and CSL Ltd.. 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.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.