By David K. Randall

Healthcare stocks, whose steady profits and dividends have long appealed to income-oriented investors, fell out of favor last year despite a rush to other defensive sectors like utilities and consumer staples.

The new year hasn't brought much relief. Healthcare stocks lag the broad Standard & Poor's 500 index by a percentage point. Meanwhile, 2011's other stragglers have jumped ahead. Financial stocks, for instance, are up 5.4 percent so far this year after a batch of strong earnings, nearly double the performance of the

S&P 500.

Politics may be playing a role in the sector's underperformance. The Supreme Court is expected to hear a challenge to the Affordable Care Act, signed into law by President Barack Obama in 2010, later this year. A Republican takeover of both the Senate and the presidency could lead to healthcare policy changes that would affect company earnings, analysts said.

How to play a healthcare sector with an uncertain future.

SIGNS OF VALUE IN THE U.S.

The broad healthcare sector may be a value play, analysts said, but only for investors willing to be patient for two trends to turn around.

First, the number of patient visits to doctor's offices in the U.S. declined by about 8 percent last year because of high insurance deductibles and the slow economy, analysts said.

That, in turn, has led to a drop in the number of patients filling prescriptions or obtaining new medical devices to treat conditions like sleep apnea. ResMed, a company that makes CPAP machines for sleep apnea, has seen its stock price fall 20 percent over the last year, in part because revenues dropped nearly 8 percent in its last quarter because fewer patients were seeking treatment. Analysts expect the slowdown to persist until the unemployment rate drops further.

Even so, Jason Mills, an analyst at Canaccord Genuity, said that some medical devicemakers look attractive after the sector's broad retreat. Hologic, which develops mammography systems and other women's health products, will likely see its margins expand over the next year as it introduces new products and continues to cut costs, Mills said. He believes the company is worth $23 a share, nearly 20 percent more than its current share price of $19.20.

A second trend requiring investor resolve to overcome: concern that profitable drugs like Lipitor have gone off-patent and there are few blockbuster drugs in the pipeline. But with no surprises in patent expiration, the inevitabilities are already priced into shares, said Daniel Genter, chief investment officer at RNC Genter Capital Management, a Los Angeles firm with $3.7 billion in assets under management.

The recent drop in share prices make pharmaceuticals look attractive as a dividend play, investors said. "These companies offer solid dividends that are like gold in this environment," Genter said.

Pfizer, one of Genter's holdings, offers a dividend yield of 4 percent. Novartis, another holding, yields 4.1 percent.

Investors can buy the broad sector with Vanguard's Health Care ETF, which charges 19 cents per every $100 invested. Global healthcare companies make up most of its assets: Johnson & Johnson, Pfizer and Merck make up nearly a third of assets, according to Morningstar. Health Care Select SPDR, meanwhile, charges 20 cents per every $100 invested. Both funds returned about 12 percent over the last year after dividends, well above the 4 percent average return in the category.

"There's very good price competition in the healthcare ETF space so you can easily get solid funds with fees under 25 basis points," said Brad Sorensen, an analyst at Charles Schwab.

TREATING THE NEW MIDDLE CLASS

Economic growth in emerging markets like China, India and Brazil is leading to a new middle class that can afford quality healthcare for the first time.

China alone is expected to increase its healthcare spending over the next decade more than France, Japan, Canada, Germany and the United Kingdom combined, said Vadim Zlotnikov, an analyst at AllianceBernstein.

That's already leading institutional investors to buy healthcare companies for their strength overseas. "We're looking for companies that have long-term demographic trends in their favor," said Allen Bond, an analyst at the $3.8 billion Jensen Quality Growth Fund.

Abbott Laboratories, one of the fund's holdings, gets about 25 percent of its sales from emerging markets, he said. The company recently expanded its line of so-called branded generics, which are generic drugs sold under brand names. Patients are willing to pay more for the drugs because they know they are not getting counterfeits.

Varian Medical Systems, another fund holding, makes pricey equipment used to treat cancer. "This is a company that has created tiered products that offer flexibility with features and pricing that we think will help them penetrate emerging markets," Bond said.

Economic progress will also likely lead to an increase in diseases like obesity and diabetes in emerging markets, Zlotnikov noted. Diabetes is expected to "become the fastest growing disease area in the emerging markets," he wrote in a recent note to clients. Some 56 million people in China have diabetes, compared with 26 million in the U.S.

Novartis, Sanofi and Eli Lilly & Co are leaders in insulin treatment and have been taking market share from local competitors in emerging markets, Zlotnikov said.

Many of these global healthcare companies are attractively priced. Eli Lilly, for instance, trades at a price to earnings ratio of 9.5, well below the 13.3 valuation of the S&P 500 index.

Johnson & Johnson, which is the second largest healthcare player in China, trades at a P/E of 15.

(Reporting By David Randall; Editing by Jennifer Merritt and Tim Dobbyn)