Healthcare Stocks Are ‘Priced at Panic Levels.’ It’s Time to Buy.

Healthcare stocks are bargains, according to a couple of key measures. Above, a pharmacy worker in Los Angeles. (Eric Thayer/Bloomberg)

Healthcare stocks are struggling. But they may be worth a second look. By at least one key measure, they’re trading at cheaper prices than they have in more than 20 years.

This bull market hasn’t been kind to the sector. The Health Care Select Sector SPDR , an ETF, is down 12% in the past year, while the S&P 500 has surged 15%.

In midday trading Thursday, the ETF was off 0.6%. So too was Eli Lilly , the fund’s largest holding. Johnson & Johnson and AbbVie were down as well—0.7% and 0.6%, respectively.

The past year’s dismal performance has cut into healthcare’s average forward price-to-earnings ratio. Today, it stands at 16.6, down from 19.7 a year ago. The rest of the market has only gotten richer.

But price-to-earnings ratios aren’t the only way to value healthcare stocks. By another important measure, the sector looks cheaper than at any time since 2000, according to a note Thursday by independent market researcher Jim Paulsen.

Besides traditional valuation metrics, Paulsen argues, investors should look at healthcare stock prices relative to real, or inflation-adjusted, drug prices. The two have largely moved in sync, according to data going back to 1990.

The cost of drugs “is a central price that defines these stocks’ existence,” Paulsen told Barron’s. “It doesn’t fit all of the healthcare industry—but it gives you a sense of where they are going.”

Inflation-adjusted drug prices have been under pressure for several years—a startling reversal after decades of prices marching upward year after year almost as a matter of course.

Last year, net prices for brand-name drugs rose 0.1% in nominal terms and fell by 3% after adjusting for inflation, according to the Drug Channels Institute, a group that tracks the industry.

The dip represented the seventh year of decline in real prices. One factor was competition—the growth of biosimilars and companies rushing to expand GLP-1 weight-loss drugs. Changes to Medicare and Medicaid drug payments have also played a role, the group said.

But if inflation-adjusted drug prices have been falling, prices of healthcare stocks have fallen much faster, according to Paulsen’s note.

Paulsen’s P-D, or (stock) price-to-drug (price) ratio, peaked in 2022 at about 0.17, and has since tumbled to about 0.1. That represents the lowest level since 2000, according to his calculations, and one of the lowest levels since 1990.

Paulsen declined to venture a guess on when exactly prices for drugs or healthcare stocks will recover. But he said the steep decline in his P-D ratio, with stock prices falling much more steeply than drug prices, almost certainly reflects an overreaction by spooked investors.

Healthcare stocks are “priced at panic levels,” he said. “It’s gone way beyond the fundamentals.”

Write to Ian Salisbury at ian.salisbury@barrons.com