The health-care sector is hot—but it's not due just to the wild ride in booming biotech.
The health-care sector as a whole has been a standout in the S&P 500, up 9 percent year-to-date through the end of May and the top sector gainer last month, with a 4 percent return. That's compared to the S&P 500's meager 2.3 percent for the year and 1 percent in May.
No health-care niche can keep pace with biotech—it just notched its best month since August with a 9.3 percent return in May. But solid returns are being generated across the broader universe of health-care stocks. Older, more established medical technology companies are a good example of a health-care bet that couples global growth with dividends.
In case you hadn't noticed, the S&P 500 Health Care Equipment Index has risen 22 percent in the past year, almost doubling the 13 percent in the S&P 500. That puts the health-care niche in line with the overall performance of the health-care sector. What analysts find attractive about the medical technology stocks is that they remain positioned for growth. Big, highly diversified medical technology companies are tapping into health-care spending spikes in emerging countries. That's in contrast to a U.S. market for medical devices that is mature and slow growing.
Emerging market countries have large, aging populations and rising incomes, which equates to 15 percent revenue growth for medical technology companies from those countries, said Gregory Chodaczek, a senior research analyst at Sterne Agee CRT.
"India and China are huge opportunities," Chodaczek said. "The pacemakers, knee replacements and the drug dispensers that have been in the U.S. for 20 years haven't shown up there yet. And hospitals will pay for them."
China's health-care spending alone is slated to triple between 2011 and 2020, according to McKinsey & Company estimates.
Top 10 holdings/S&P 500 Health Care Equipment Index
Take Medtronic, which makes pacemakers, defibrillators and the like. Revenues from emerging market countries is its fastest-growing segment, said Joanne Wuensch, a research analyst at BMO Capital Markets.
Wuensch sees growth for Medtronic overseas based on its acquisition of Irish hospital-supply company Covidien for $42.9 billion. The acquisition, one of the largest in the industry, adds revenue, cost savings and valuable products, but another key is that Covidien sells its technology in 150 countries, including emerging markets.
Medtronic hasn't been among the biggest winners in the space of late—its stock is up only 6 percent so far this year. One reason is that the FDA asked Medtronic to halt sales of its drug-infusion pump for patients who have back pain. "You never want a product taken off the market," Chodaczek said. But among the more than 400 products that are sold by Medtronic, "the pump was never a strong product. One single product doesn't really move the needle," he explained.
Chodaczek said that Medtronic is a good stock to buy and hold for three years, since investors won't have to worry about it. Medtech stocks don't go up and down very fast, he said. And Medtronic should also have a nice, steady return over several years.
Medical technology stocks can experience short-term selloffs, but they tend to be more stable growers over the long term. Debbie Wang, a senior equity analyst at Morningstar, said with short stays in the doghouse and pipelines that are attractive, these are health-care stock bets that won't keep you up at night.
Consider medical device maker Boston Scientific, which had been in the doghouse among medical technology stocks in the past decade, seeing successive management changes and regulatory obstacles. But still, it's returned 176 percent over five years and has really rallied of late, up 37 percent this year. Its emerging markets angle is taking shape as it moves into Russia, China and Brazil. The company wants to get 15 percent of its sales from emerging markets by 2017, Chodaczek said.
"Boston Scientific is moving in the right direction, Wang said, but added that it has been late to the emerging markets party, though, and lacks Medtronic's existing access to a large network of distributors.
A diversified health-care company that is poised for emerging markets growth is Abbott Laboratories. It's not among the largest holdings in the S&P Health Care Equipment Index because it's not a pure-play device name but split between device and pharmaceutical sales, but half of sales do come from emerging markets, including India and China, according to Zacks Investment Research estimates. And Abbott is strengthening its hand even further, spinning off its developed-market businesses to focus on faster-growing ones.
"Abbott has an attractive business," Wang said, "and it has a strong competitive advantage."
Reasonable dividends are part of the medical technology stock appeal—they can't be called dividend standouts, but they pay out at reasonable levels and have a long history of dividend stability. For example, Abbott currently yields 2 percent—in line with the S&P 500 dividend level—but the medical stocks have a long history of raising its dividends. Medtronic, which yields 1.6 percent, is also a dividend machine, increasing its payout for over 35 years.
—By Constance Gustke, special to CNBC.com
Correction: This article has been updated to reflect that Gregory Chodaczek is a senior research analyst at Sterne Agee CRT.