ObamaCare Portfolio Picks

Health care inflation is coming. Profit from these money-saving firms.

According to PricewaterhouseCoopers health care prices are likely to rise 8% in 2011 and 8.5% next year. So much for ObamaCare bending the cost curve. Cost cutting will likely be left to employers, as they attempt to offer insurance to workers without going broke.

Venture capitalist Stephen Krupa sees opportunity in this mess. His New York City firm, Psilos, manages $580 million in funds that invest exclusively in health care IT, device and services companies. "Our sole focus is to fight health inflation," says the former Wasserstein Perella banker. "If you look at the CBO projections and take them seriously, which is hard to do, there is a tail-off in inflation underlying the models. How can you make that assumption? There have to be technological breakthroughs."

Krupa's portfolio of private companies chips away at costs, each in a different way--by offering a medical device at a lower price, a technology that makes buying insurance or measuring risk more efficient, or a service that pushes delivery away from acute care and toward prevention. His biggest hit has been ActiveHealth Management, a company that uses analytical software to help insurers get ahead of expensive diseases. Aetna ( AET - news- people ) bought it for $400 million in 2005, returning seven times Krupa's investment. Last year UnitedHealth ( UNH -news - people ) bought another Psilos company, called QualityMetric, a patient-surveying firm that measures drug efficacy. Krupa says he earned a 500% return on the deal.

Right now Krupa is pushing the cost-cutting angle with several other new investments. SeeChange, a small insurer in California, discounts premiums based on how much preventive care a patient gets. Gamma Medica has developed a new kind of camera that scans dense breast tissue for tumors; the scan costs a third of an MRI. It's already in use at hospitals like Mayo Clinic. ExtendHealth brokers health care and pension plans for retirees. It's gearing up for the new health exchanges that open in 2014.

It's more difficult to find serious inflation-fighting companies among publicly traded stocks. Big device companies likeMedtronic ( MDT - news - people ), Johnson & Johnson (JNJ - news - people ) and Boston Scientific ( BSX - news -people ) sell expensive products that fuel the cost surge. Meanwhile, many HMOs have abdicated the role of managing spending and are turning into commoditized claims-paying utilities.

Krupa sees a few exceptions. On the insurance side Aetna and UnitedHealth seem the most committed to becoming clinically oriented--that means using data-mining technology to identify expensive patients and then deploying preventive clinical programs to keep them out of the hospital. Krupa also believes that the insurance companies that gain market share will be the ones that embrace "value-based design"--in which you pay for health outcomes and not just for procedures and office visits. Both United and Aetna are piloting such projects.

As for the IT side? "This is not an industry where the technology departments have been innovators," says Krupa. An exception is Allscripts, the Chicago software company that specializes in digitizing records at doctors' offices. Allscripts sells the database of records and the interface for the doctor and has an open-source approach to applications running on its platform.

Among device companies, Krupa recommends the women's health company Hologic ( HOLX - news - people ). Like Gamma, Hologic is pioneering an imaging technology called tomosynthesis for patients who need more than a mammogram but don't want to pay $1,000 for an MRI. Another Krupa pick is NxStage, a home-dialysis technology firm that's disrupting dialysis centers like DaVita ( DVA - news - people ) and Fresenius.

RIDING THE HEALTH COST CURVE
DESPITE OBAMACARE'S CLAIMS, HEALTH CARE INFLATION IS A SURE THING. HERE ARE STOCKS THAT SHOULD BENEFIT.

COMPANY	RECENT PRICE	2011 EST P/E	MARKET VALUE ($MIL)
AETNA	$43.79	10	$16,618
ALLSCRIPTS HEALTHCARE SOLUTIONS	20.02	22	3,808
HOLOGIC	20.64	17	5,395
NXSTAGE MEDICAL	18.01	NA	978
UNITEDHEALTH GROUP	49.39	12	53,511

PRICES AS OF JUNE 2. NA: NOT AVAILABLE. SOURCE: INTERACTIVE DATA AND THOMSON REUTERS IBES VIA FACTSET RESEARCH SYSTEMS.

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Investing On the Frontier

Geritz and Edgley are the Lewis and Clark of global investing, uncovering stocks in parts of the world Wall Street ignores.

In April fund manager Laura Geritz spent five days in Chile and Argentina touring a hospital, a port operator, a grocery store and a sporting goods retailer. All told, she met with the CEOs of 25 small publicly traded companies. It's the kind of boots-on-the-ground investing that few institutional money runners practice anymore. Geritz and her partner, Roger Edgley, are in search of stock gems for the $800 million fund they comanage, Wasatch Emerging Markets Small Cap Fund.

"Sixty percent of the companies we saw have no coverage" by equity analysts, says Geritz. Some hadn't seen an investor in a year and a half. "There were no presentations. We just walked through the businesses freely."

So far just one company Geritz had visited made the fund managers' cut: Chilean retailer Forus, although the investment is still pending registration in Chile.

Home for Geritz and Edgley is Salt Lake City, where together with their six researchers they screen an ever expanding universe of 6,000 small foreign companies for candidates worth a visit. Their criteria: companies with market values of less than $3 billion, a 15% revenue growth rate and enough cash flow to support the growth. Their goal: a 20% annual return on each stock over a three- to five-year holding period.

The team is finding India, Brazil and Indonesia to be the most fertile spots for stocks, and most of the picks are in the discretionary consumer spending, financial services and manufacturing sectors. Some, like Colgate-Palmolive( CL - news - people ) India Ltd., are subsidiaries of big multinationals. A fifth or more of the firms considered have no more than two analysts covering them.

Vetting such outfits goes way beyond spreadsheet number crunching. The team averages about three months on the road annually, visiting places like Chinese factory floors, Brazilian retail showrooms and Philippine gold and copper mines. Geritz recently received eight vaccinations, including one for yellow fever, in preparation for a July trip to Nigeria, Ghana and Kenya, where she will visit 30 to 50 companies.

"We work in an asset class that's still undiscovered," says Edgley. "It's a little bit like being in the jungle. You're trying to figure out different economic behavior, consumer trends--you're a perpetual student, you're never an expert."

During a trip to Brazil two years ago Geritz learned about Hering, Brazil's Gap ( GPS -news - people ) equivalent, while walking through a mall with the CFO of Lojas Renner, a competitor the fund was already invested in. "It fit our process beautifully," says Geritz. "It had great high-quality numbers and a balance sheet with net cash, and at the time it had zero analysts, which is another advantage of our universe--we have a first mover's advantage at finding these names." Geritz had a call with Hering's management and soon added it to the portfolio. Hering's stock has since shot up 480%.

The no-load fund, created in October 2007, has performed among the top 1% in the diversified emerging market category for the three years through March, according to Morningstar. In 2008 Wasatch got hammered with other emerging market funds, down 57%. The next year it was up 118%, and in 2010 its total return was 41%, nearly double the emerging market fund average.

As with other funds that invest in frontier markets, Wasatch's expense ratio is fairly steep at 2.39%. So far this year the fund is flat, mostly because its Egyptian stock holdings--including Egyptian Financial Group (EFG) Hermes Holding, Nationale Société Générale Bank and Paints & Chemicals Industries--were slammed when the Mubarak government was overthrown.

While grassroots detective work on stocks sometimes uncovers hidden treasures, it's also useful in avoiding disasters. Last February when an analyst went to visit a farm equipment factory in mainland China, he discovered that not even the locals had heard of it. It turned out to be an empty building with five men sitting on the ground out front smoking cigarettes.

The risk of buying into duds and even outright scams is inherent when investing in untrodden regions of the globe, where businesses practices run the gamut. That's why Geritz spreads her bets. "A portfolio of 20 countries that have relatively good fiscal health versus a one-country developed market portfolio should be less risky."

Still, hitting the road is essential. Last July Geritz drove in aToyota ( TM - news - people ) Land Cruiser to the bottom of a copper mine in the Philippines, where she spent eight hours talking with workers and exploring the operation. The visit plus the stock's rising price was enough to convince Geritz and Edgley that miner Philex was fully valued. The fund sold its shares soon after.

More recently Singapore's Hsu Fu Chi International Ltd. caught Geritz's eye. The $2.5 billion (market cap) family-owned company sells confectionery goods in China. It's trading at 21 times earnings.

At a time when emerging markets like Brazil and China have been all the rage among investors, Edgley insists small caps remain an overlooked sector. He says, "We realized a few years ago that investors weren't paying enough attention to emerging small caps." A few more years with 40%-plus returns should change that.

OFF THE BEATEN TRACK
WHILE MANY HAVE RUSHED INTO CHINA, WASATCH EMERGING MARKETS SMALL CAP IS FINDING BARGAINS IN INDIA, INDONESIA AND BRAZIL. STILL, ITS MANAGERS ARE HEDGING THEIR BETS. THE FUND HOLDS 116 STOCKS IN 23 COUNTRIES.

COMPANY COUNTRY	BUSINESS	TOTAL RETURN YEAR- TO-DATE	% OF FUND*
MR PRICE GROUPSOUTH AFRICA	BUDGET CLOTHING AND HOME PRODUCT RETAILER	-4.9%	2.2%
HOLCIM INDONESIAINDONESIA	SUBSIDIARY OF SWISS MULTINATIONAL CEMENTMAKER	5.5	2.1
COLGATE-PALMOLIVE INDIA LTD INDIA	PERSONAL HYGIENE PRODUCTS	6.7	1.9
MAHINDRA & MAHINDRA FINANCIAL SERVICES INDIA	CONSUMER LENDER IN RURAL AND SEMIRURAL INDIA	-10.8	1.9
CLICKS GROUP SOUTH AFRICA	FOOD AND DRUG RETAILER	-1.8	1.8
HARUM ENERGYINDONESIA	OPERATES 2 COAL MINES IN EASTERN INDONESIA	10.8	1.5
BATA INDIA INDIA	SHOE MANUFACTURER	37.5	1.4
DAH CHONG HONG HOLDINGSHONG KONG	LUXURY CAR DISTRIBUTOR	-2.8	1.4
RESTOQUE COMERCIO E CONFECCOES DE ROUPAS BRAZIL	LUXURY FASHION AND HOME PRODUCTS DESIGNER	30.7	1.4
TEGMA GESTAO LOGISTICABRAZIL	TRANSPORTS CARS FOR AUTO INDUSTRY	5.5	1.4

PRICE PERFORMANCES ARE IN U.S. DOLLARS AND AS OF JUNE 2. *AS OF MAR. 31. SOURCES: INTERACTIVE DATA VIA FACTSET RESEARCH SYSTEMS; WWW.WASATCHFUNDS.COM.

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Tech On The Cheap

Do you like tech stocks but hate how they're priced? Consider chip stocks.

Nosebleed names." That's the phrase Paul Wick, manager of the $4.2 billion (assets) Columbia Seligman Communications & Information fund, uses to describe most of the stocks that are bubbling around tech today. He is talking about stocks likeSalesforce.com ( CRM - news - people ), Success Factors and Concur Technologies ( CNQR - news - people ), all trading for upwards of 280 times earnings.

"We pay a lot of attention to value," says Wick, from his Menlo Park, Calif. office. Wick, 48, has spent the past 22 years investing in tech stocks and riding out their notorious peaks and valleys. During the past decade his fund has returned 10.3% annually, four percentage points a year better than its peer average, even after 1.36% in annual fees.

Wick's current favorites are semiconductor stocks where price/earnings ratios hover at 13, versus a historical 22. Volatility has plagued this sector, but Wick says an era of calm is ahead because the migration to a new generation of 18-inch wafers is at least four years away.

One industry metric Wick watches closely is capital intensity, defined as spending on wafer-fabrication equipment divided by chip industry sales. In 2010 semiconductor makers spent $30 billion on fab gear, or 9.7% of their $310 billion in revenues. Wick expects spending this year to reach $34 billion, or 10.6% of revenues. "The industry gets into trouble when the ratio hits 15%," says Wick. "It tells you that capacity has to be digested and people have to pause spending."

KLA-Tencor ( KLAC - news - people ) is a favorite. The company makes gear used to find defects in silicon wafers. It controls 70% of the world market in its main businesses and is sitting on $6 per share in cash. Wick figures the Milpitas, Calif. firm will earn $5 per share in 2011. "After [deducting] the cash you're paying seven times earnings for a dominant franchise with 37% or 38% pretax profit margins," he says.

Wick is also keen on Novellus, whose primary products are machines that deposit chemical vapors on semiconductors. The company struggled in the first half of the decade but has since boosted gross margins to 50% and operating margins to roughly half that. Novellus is likely to benefit from Intel ( INTC - news - people )'s expected doubling of capital spending this year and is poised to earn at least $3.80 a share, giving it a value stock P/E of nine. Wick thinks Novellus could get acquired by Lam Research or Tokyo Electron.

Among chipmakers, Wick likes AMD best. He figures the company "is going from famine to feast with respect to its portfolio" after bad moves, like its 2006 acquisition of graphics chip maker ATI, which crippled AMD's balance sheet. The good news for AMD is that it's begun shipping its Llano family of processors for notebooks and desktop PCs. Wick believes The Street's consensus for AMD's net income is 35% too low and that it will earn well over a dollar per share in 2012. At a recent $8.24 AMD trades at 11 times Wick's projected 2011 earnings. Compared to those nosebleed software stocks, it's a steal.

CHIP INDUSTRY CHEAPIES
WICK'S MENU OF TECH BUYS--HOLD THE INFLATED MULTIPLES.

	PRICE
COMPANY	RECENT	52-WEEK HIGH	PE	MARKET VALUE ($MIL)
ADVANCED MICRO DEVICES	$8.24	$9.58	9	$5,662
ASML HOLDING	38.39	45.92	9	16,761
KLA-TENCOR	41.72	51.83	11	7,005
NOVELLUS SYSTEMS	36.05	41.82	11	3,220
SYNOPSYS	27.19	29.35	21	3,988

PRICES AS OF JUNE 2. SOURCE: INTERACTIVE DATA AND THOMSON REUTERS FUNDAMENTALS VIA FACTSET RESEARCH SYSTEMS.

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