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Look for Health Stocks to Stop Lagging, Start Leading

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Healthcare stocks have been a laggard so far this year. That presents an opportunity for investors, because a strong second-quarter earnings season is in the cards.

Health stocks have returned about 13% so far this year, falling behind the S&P 500 by about three percentage points. But there is reason to think the sector will catch up. After all, insurance giant and industry bellwether

UnitedHealth Group’s

UNH 1.34%

second-quarter results show that pandemic-driven disruptions are coming to an end.

UnitedHealth said Thursday that it spent nearly 83% of premiums on medical care for its patients in the quarter. A year ago that was about 70%, an abnormally low figure as patients deferred routine care. That bodes well for a host of medical device manufacturers, hospital operators and drug companies, which will begin reporting second-quarter earnings next week.

UnitedHealth profits were lower compared with a year ago, but results were still strong. The company reported sales of $71.3 billion and adjusted earnings of $4.70 a share, both of which topped analyst expectations. UnitedHealth raised its profit outlook and now expects to earn $18.30 to $18.80 a share in 2021.

The stock fell slightly Thursday morning, but one down day shouldn’t trouble investors. The stock is up 27% since its lows in February. UnitedHealth expects a pandemic-related hit to profits this year of about $1.80 a share, most of which is expected in the second half of the year and seems unlikely to recur. That includes Covid-19 testing and treatment expenses, the impact of patients catching up on deferred care, as well as higher unemployment and other economic effects.

Add back those expenses, and UnitedHealth still trades at 20 times this year’s adjusted earnings. That is no screaming bargain, but nor especially expensive by recent historical standards. Investors should also keep in mind that the company has developed a reputation for issuing conservative guidance; exceeding its own expectations is a matter of routine.

And insurers like UnitedHealth still enjoy strong pricing power, favorable long-term demographics and a friendly regulatory framework. The high cost of care is an evergreen political issue, so health investors should always keep an eye on Washington, D.C. Yet the sector faces no serious regulatory threat in the short term.

In the meantime, the return of patients to doctors’ offices means that health stocks should stop lagging and start leading.

Write to Charley Grant at charles.grant@wsj.com

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