So you're ready to crush the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) by buying healthcare companies.
Great choice!
There are some fantastic, globally diversified companies which make up the S&P/ASX 200 Health Care Index (Index: ASX: XHJ), many of which churn out huge returns. But where should you start?
A valuable metric to look at here is return on equity (ROE). Return on equity reflects the return a company generates on funding provided by investors. A high return on equity can provide the means to invest back into the company for years, or to return funds to investors via dividends or share buy-backs.
By an absolute mile, the two standouts from the Health Care Index are CSL Limited (ASX: CSL) and Cochlear Limited (ASX: COH), with returns on equity of 50% and 41% respectively. Both companies have strong proprietary product lines and naturally growing demand to support earnings going forward. Here is how they compare to some of the other big name ASX healthcare companies:
| Net Income ($millions) | Total equity ($millions) | ROE | Debt/equity | |
| CSL Limited (US$) | 1,379 | 2,747 | 50% | 1.3 |
| Cochlear Limited | 147 | 355 | 41% | 1.4 |
| Sirtex Medical Limited | 40 | 145 | 28% | 0.4 |
| Fisher & Paykel Healthcare Corp Ltd | 113 | 471 | 24% | 0.4 |
| Ramsay Health Care Limited | 419 | 1,833 | 23% | 3.1 |
| ResMed Inc. | 353 | 1,587 | 22% | 0.4 |
| Ansell Limited | 189 | 1,166 | 16% | 1 |
Source: company 2015 annual reports
Both CSL and Cochlear also have what I view as appropriate debt levels given the returns they are making, and the sustainability of these returns, make servicing their debt manageable.
This is really important since one way companies can jack up their return on equity is by funding operations with more debt and less equity. Ramsay Health Care Limited (ASX: RHC) for example has a big pile of debt equivalent to over 3x the company's equity. This is not necessarily bad, especially given Ramsay's strong projected growth over the coming years, but it does increase risk.
Of the remaining companies listed above, my pick would be ResMed Inc. (CHESS) (ASX: RMD). ResMed has an attractive, boring quality which I like. Although the company has a lower ROE than both Sirtex Medical Limited (ASX: SRX) and Fisher & Paykel Healthcare Corp Ltd (ASX: FPH), I currently prefer ResMed's valuation to that of Fisher & Paykel Healthcare and prefer ResMed's lower risk profile to that of Sirtex.
