Healthcare stocks appear inexpensive, but proceed with caution

If US policy uncertainty subsides, healthcare company shares may rise, but are they worth the risk?

Investors in the healthcare industry may disagree with the adage that "health is wealth." The last few years have been difficult for the industry. Although US policy noise has been a significant obstacle lately, investors' attention was already diverted elsewhere as sectors like technology advanced. In a study for JPMorgan, Michael Cembalest observes, "The US healthcare sector closely tracked technology returns for the 30-year period from 1989-2019, and with considerably lower volatility." After that, things have evolved.

Compared to the broader MSCI World index, which has returned 13 percent over the past five years, the MSCI World Health Care index has produced returns of less than 6 percent. Over the same time frame, the MSCI World Information Technology index has improved by 17%. In 2025, sentiment toward the industry has deteriorated even more, and it is simple to comprehend why. Trump appointed a vaccine skeptic as his health secretary as soon as he took office in January, despite the fact that the US has the largest healthcare market in the world. This established the tone for what came next.

Tariffs, potential tax changes, and attempts to regulate drug prices are the three main threats. The sector is undoubtedly trading at a discount. The question is whether, given the risks, it provides good value.

Three large, lovely policy risks.

Regarding drug prices, Donald Trump believes that American consumers are being taken advantage of. According to him, a friend in London spends £88 on a weight-loss program that would cost £1,300 in New York. He therefore issued an executive order earlier this year requesting "most-favoured nation" prices for US clients in an effort to align US prices with the lowest prices available abroad. "Every tool in the federal governments arsenal" has been threatened to pharmaceutical companies if they don't step up. Even though the threat is ambiguous, it has nevertheless caused anxiety.

According to the University of Southern California, the US market accounts for about 70% of all pharmaceutical profits worldwide. Companies could choose to withdraw from less profitable markets instead of lowering prices in the US, which would limit patient access to medications and hurt pharmaceutical companies' bottom lines.

Second, tariffs pose a threat. Trump is using tariffs to increase US manufacturing because he wants to do so. On October 1st, he announced a 100 percent tax on the import of branded or patented medications; however, manufacturers who are constructing a facility in the United States will be exempt. Investors should think about other taxes besides tariffs. The corporate income-tax breaks that pharmaceutical companies have been taking advantage of are another area of concern for the Trump administration. According to a US Senate Finance Committee investigation, Pfizer sold £20 billion worth of medications in the US in 2019 but paid no federal taxes. This resulted from the round-tripping mechanism, which makes US sales revenue appear foreign to tax authorities. This can be accomplished by moving intellectual property rights to tax havens or by employing offshore manufacturing. In a March podcast, Commerce Secretary Howard Lutnick stated, "We're going to try and fix a whole bunch of these tax scams."

Is everything as horrible as it seems?

It is possible that some of the risks were exaggerated. Examine the "most-favoured nation" pricing feature. There is doubt that Trump will be able to carry it out on any significant scale. He attempted to regulate the cost of a few Medicare-covered medications during his first term, but a federal judge blocked his efforts. This time around, broad price controls would most likely need congressional support, which Congress doesn't seem to want.

Pharmaceutical firms, meanwhile, have been taking action to try to avoid tariffs. The restrictions, which go into effect at the beginning of October, only apply to businesses that are not constructing a site in the United States. Numerous companies have made commitments in recent months. Swiss and British behemoths Roche and AstraZeneca announced in July that they would invest £50 billion in the US over the following five years to construct and expand manufacturing and research facilities. By this date, 50% of AstraZeneca's revenue is expected to come from the US, the company stated.

Large commitments to domestic manufacturing have also been made by US pharmaceutical companies. Eli Lilly promised an extra £27 billion for four new plants earlier this year, and Johnson & Johnson said they would invest £55 billion over the following four years.

Although this will assist the industry in navigating tariffs, some businesses may lose tax benefits if they relocate their manufacturing operations to the United States. As the restructuring proceeds, analysts have been increasing tax rates in their models over the coming years, according to Karen Andersen, research director at Morningstar.

Stocks in the healthcare industry are dropping in value.

The sector's headwinds make valuations appear low. Currently trading at about 16 times its projected earnings, the MSCI World Health Care index is outperforming the MSCI World index by 20 times. Lower multiples are being used to trade individual names. According to Cembalest, "biotech trades at one of the largest valuation discounts in the market, and pharmaceutical stalwarts like Merck, Pfizer, and Bristol Myers Squibb trade at forward price/earnings (p/e) ratios of just eight to nine times." The question is, given the risks, is it worth it?

On the one hand, we are beginning to understand Trump's methods better. As a result, recent stock market responses have been less noticeable. 17 pharmaceutical companies received letters from Trump in July warning of consequences if they did not implement most-favorable nation pricing. The news was mostly dismissed by investors. The most recent tariff announcement has also been well received by markets. According to global market analyst Lale Akoner of the investment platform eToro, "investors see more bark than bite." The goal of tariffs is to compel US supply chains to operate domestically rather than to raise prices at the pharmacy. "US companies benefit from a policy tailwind, while European pharmaceutical companies are pushed to localize." Nevertheless, as long as the policy outlook is unclear, valuations are probably going to stay suppressed. Think about the pricing of the most favored nation. "The problem is that the impact is so big that its a difficult risk for the market to ignore, no matter how unlikely it might be," Andersen says of Trump's plan, which sounds overly ambitious.

Is it worth the risk to invest in healthcare stocks?

The industry underperforms whenever there is anxiety about pricing in the US, according to a fund manager with 25 years of experience in the industry. Gareth Powell, head of healthcare at Polar Capital, states that investors need clarity on the earnings forecast before purchasing more of this stuff. In the upcoming months, we might gain more assurance. Pharma behemoths were given until September 29 to abide by Trump's price demands. The treatment of regions with existing trade agreements remains uncertain, despite the fact that more information on tariffs has already surfaced.

According to Ailsa Craig and Marek Poszepczynski, co-managers of the International Biotechnology Trust, "headlines regarding the imposition of 100 percent tariffs on branded drugs appear to contradict the previously discussed 15 percent cap for European firms." It takes courage to hunt for deals in this industry until these pieces of the puzzle fit together.

Positively, there have been some encouraging moments. The FDA regulator's pro-industry rhetoric, which includes a pilot program to shorten the review period for new medications and treatments from 10 to 12 months to just one or two months, provided they meet specific requirements, is cited by biotech investors. This is a significant change from earlier this year, when investors were concerned that the FDA's mass layoffs would cause approval procedures to move more slowly.

In order to control the risk of policy threats, active investors can also modify their portfolios. According to Andersen, "I would approach it on a case-by-case basis." Does the business have a sizable manufacturing presence outside of the United States? Is it especially dependent on government reimbursement for one of its primary products? The International Biotechnology Trust is reducing risk by focusing on rare diseases, allocating over 30% of its portfolio to this theme. According to Craig, "this tends to be much more similar in price in both Europe and the US," which means that treatments should be less vulnerable to Trump's meddling with drug prices.

In which location should I invest?

The Polar Capital Global Healthcare Trust (LSE: PCGH) is a good option if you want to gain extensive exposure to the industry. The trust holds significant over-weight positions in biotechnology and medical equipment. It is underweight on pharmaceuticals in comparison to the benchmark, a stance motivated by worries about how Trump's price threats will affect mega-cap pharmaceutical firms. Although active stockpickers might benefit more from today's unstable policy environment, those who prefer passive exposure might consider the Xtrackers MSCI World Health Care ETF (LSE: XDWH).

In my perspective, biotechnology appears to be the most intriguing field. The majority of innovation takes place here, as large pharmaceutical companies quickly buy out biotech companies that are creating a promising medication. A major patent cliff-edge for big pharma is imminent, so we should expect more merger and acquisition (M&A) activity in the upcoming years. According to statistics reported in the Financial Times, drugs with an annual revenue of £180 billion, or 12% of the world market, will be taking their patents off in 2027 and 2028. Because of this, pharmaceutical companies are under pressure to look for new products in the biotech industry.

This segment of the market is exposed by the International Biotechnology Trust (LSE: IBT). As a result of the managers' excellent ability to spot acquisition targets, 30 portfolio holdings have been acquired through M&A since 2020. Though biotech investing is risky, companies with drugs in late-stage clinical trials and those that have already finished trials and are awaiting regulatory approval are given a lot of trust. It is therefore a wise choice.