The Best Return on Equity in Healthcare

By Markets Fool.com

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Source: GlaxoSmithKline

What's a good way to compare different stocks? One of the best methods of comparison is to look at stocks' returns on equity, or ROE. This financial metric shows the amount of net income as a percentage of shareholders' equity. Shareholders' equity, also known as book value, is calculated by subtracting total liabilities of a company from its total assets.

It's best to use ROE for comparing stocks within the same sector. Different dynamics drive different sectors. But looking at ROE values for stocks in the same sector can help investors more effectively stocks to put on their watchlists. If you're wanting to buy healthcare stocks, for example, examining ROE is a good place to start. These three stocks have the best returns on equity across all of healthcare.

1.Catalent
The highest ROE among healthcare stocks with a market cap of at least $250 million belongs to a company you might not have heard of. Catalent's ROE currently stands just under 218% -- twice as high as the second-place healthcare company.

While Catalent's initial public offering was less than a year ago, the company isn't new to the scene. Cardinal Health spent years scooping up oral drug delivery technologies before ultimately spinning off the business in 2007, which ultimately became known as Catalent.

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Catalent focuses on three different areas -- oral technologies, medication delivery solutions, and development and clinical services. Oral technologies generate over 60% of total revenue and nearly 90% of total earnings. What's really impressive about this business model is that nearly half of new chemical entities approved by the FDA over the last decade relied on Catalent's technology in some way!

Catalent's ROE is impressive, but some of its other financial metrics aren't. For example, revenue dropped slightly last quarter compared to the same quarter in 2014. Catalent's profit margin is less than 5%. And the company carries $1.88 billion in debt on its balance sheet with a little over $116 million in cash (including cash equivalents).

2.GlaxoSmithKline plc
Big pharmaceutical company GlaxoSmithKline claims the No. 2 spot on our list with a return on equity of nearly 108%. Glaxo's products include household names like Aquafresh toothpaste and Nicoderm patches and prescription medications from Advair to Zantac.

Glaxo looks attractive on other financial measures also. The stock's trailing price-to-earnings multiple is a low 6.58. Glaxo's profit margin of over 44% isn't bad at all. And Glaxo's dividend yields 5.3% with a low payout ratio of only 41%.

Before you rush to buy this stock, though, you might want to consider some challenges facing GlaxoSmithKline. Blockbuster respiratory drug Advair is experiencing declining sales and could be in for more difficulties when the patent for the Diskus inhaler expires next year. Glaxo also recently made a big bet by selling its oncology business and acquiring the vaccine business of Novartis. There are a lot of things in flux for this drugmaker that could drag that lofty ROE value downward in the near future.

3.Medivation
Medivation's return on equity of just under 104% ranks it as the top biotech stock and third-highest healthcare stock. The company's success comes from prostate cancer drug Xtandi, which generated over $129 million in revenue for Medivation in the first quarter this year.Xtandi racked up over $1 billion in sales in 2014. Medivation splits this revenue with collaboration partner Astellas Pharma.

Outside of ROE, Medivation's financial metrics are something of a mixed bag. The biotech saw strong revenue growth last quarter, but earnings dropped from the same quarter in the prior year. Medivation's balance sheet looks pretty solid, with debt of a little over $245 million and cash of almost $569 million. However, the stock appears to be pricey with a trailing P/E of 32 and forward multiple just below 30.

Medivation's future success, like its current success, rides on Xtandi. Several clinical studies are currently under way for the drug in other stages of prostate cancer. Xtandi also is being studied as a potential treatment for breast cancer. Good news on those fronts should keep Medivation rolling.

Looking ahead
If we only used ROE as our criterion for selecting a healthcare stock, Catalent would win hands down. However, basing an investing decision on just one factor is never a smart idea.

My view is that Catalent should continue to do well. It has a solid business model and a diverse customer base. On the other hand, don't expect sizzling earnings growth for Catalent.

I'm taking a wait-and-see stance with Glaxo. Maybe the Novartis deal will turn out to be a good one. With generic competition for Advair on the way, though, I'm leery of this Big Pharma stock despite its compelling ROE.

Out of the three, I'm most bullish about Medivation. Xtandi should continue to perform well. And I wouldn't be surprised to see a bigger player ultimately buy Medivation.

The article The Best Return on Equity in Healthcare originally appeared on Fool.com.

Keith Speights has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. 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.