Stocks in medical sector have been in the limelight for quite some time. Yesterday, I researched over 400 stocks in the medical sector. These stocks belong to diverse subsectors (9 in number) such as Biomedical, Dental Suppliers, Generic Drugs, Health Maintenance Organization (HMO), Hospitals, Nursing Homes, Outpatient & HM Care, Medical Instruments, and Medical Products.

My research theme was to spot 7 medical stocks that have given highest returns so far (YTD – year to date) and are likely to continue the trend in the remainder of calendar year 2009 (CY2009).

You might be surprised to know that, all the 7 stocks belonged to the biomedical subsector. These stocks in the order of YTD return are - RAPTOR PHARMACE (RPTPD, 52 week high and low: $55.88 - $24.51, YTD return:2,476.92% ), VANDA PHARMACEU (VNDA, $16.65 - $0.45, 2,108%), OPEXA THERAPEUT (OPXA, $6.93 - $0.09), KERYX BIOPHARMA (KERX, $3.33 - $0.09, 913.64%), HUMAN GENOME SC (HGSI, $22.78 - $0.45, 772.64%), HELICOS BIOSCIE (HLCS, $3.54 - $0.21, 633.33%), and NEUROGESX INC (NGSX, $9.2 - $0.81, 605.98%). Now, you should know why these stocks have been giving such high returns – just look at the last column in the braces – these stocks have been penny stocks at some point in CY2009. So, we drop them from our research lenses.

Our stock universe

To eliminate penny stocks we chose only those stocks whose 52 week low price was above $1 so far in CY2009. Since we need to pick seven bull stocks, let's expand our stock universe to 21 and then prune that to seven. Our 21 stocks belong to just 6 subsectors namely Biomedical, Generic Drugs, Hospitals, Nursing Homes, Medical Instruments, and Medical Products. Before we proceed with further selection – let's eliminate those stocks which don't have YTD return (because their listing history is less than year). So, we eliminate MEDNAX INC (MD, $55.88 - $24.51), TRANSCEPT PHARM (TSPT, $15 - $1.11), ARCA BIOPHARMA (ABIO, $13.45 - $2), HEARTWARE INTER (HTWR, $32 - $18.4), and CARDIOVASCULAR (CSII, $11.8 - $4.78). Even after elimination our stock universe retains all the seven subsectors.

Now our universe consists of RINO INTL CORP (RINO, $24.4 - $2, 574.29%), DENDREON CORP (DNDN, $30.42 - $2.55, 500%), TARGACEPT INC (TRGT, $22.5 - $1.4, 466.57%), HI-TECH PHARMAC (HITK, $24.61 - $3.46, 323.83%), ASPECT MEDICAL (ASPM, $12.14 - $2.5, 252.2%), BROOKDALE SENIO (BKD, $20.41 - $2.5, 252.2%), AFFYMETRIX INC (AFFX, $9.93 - $1.78, 224.08%), AFFYMETRIX INC (SIRO, $30.61 - $8.47, 188.86%), DEXCOM INC (DXCM, $8.96 - $1.36, 185.51%), VICAL INCORPORA (VICL, $5.51 - $1.04, 180.85%), ELECTRO-OPTICAL (MELA, $10.95 - $2.29, 174.93%), HEALTH FITNESS (FIT, $8.87 - $1.55, 166.06%), I-FLOW CORP (IFLO, $12.95 - $2.01, 162.08%), and NXSTAGE MEDICAL (NXTM, $7.14 - $1.9, 152.43%).

Narrowing down to eight

We should choose those stocks that exhibit enough trading liquidity; otherwise we may end up unable to execute a transaction. Setting liquidity at or above average volume of 500,000, we eliminate MELA, SIRO, DXCM, TRGT, FIT, NXTM, and OSTE. We are now left with just eight stocks from which we need to eliminate just one.

Dig deeper

It is easy to drop VICL from our 7 bull stocks as its relative strength (A technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset.) is clearly the lowest at 43.56%. Similarly, we can drop AFFX whose weighted alpha (The Alpha is a measure of how much a stock has risen or fallen over a one-year period.) is the lowest at 66.7. However, we won't do so, as we are more focused on other fundamentals.

Final seven based on 1 year target price

We can endlessly debate which stock to drop based on the metric we choose. Since our research focus is to pick those stocks that are likely to give higher returns, we fix the metric as 1 year target price appreciation.

Since, AFFX and HITK do not differ much on one year target price appreciation one can drop any of them from their portfolio. However, I suggest one should retain AFFX as it has higher potential for price appreciation over two or three year holding period.

I believe this portfolio of medical stocks is diversified enough for a retail investor considering picking 7 bull stocks in medical sector.