No Price Too Low

Wellpoint trades at less than seven times next years expected earnings. HMOs generally trade at 13 times earnings which would imply a target price of $110. I assumed that the reason Wellpoint was so cheap was because of the uncertainty surrounding Obamacare. While I knew that a bad Supreme Court decision would hit the stock I thought the damage would be minimal as a bad outcome seemed like it was already priced in. I was wrong as the stock is down 10% since the decision.

The market has been absolutely brutal to any stocks with "issues". No price seems to be too low for a stock with uncertainty. I wrote a post a few weeks back about how recently valuations did not offer much support to stocks. I pointed to the sheer number of value traps in recent years. In addition many market participants operate with "risk management" which equates to a stop loss, so losses beget losses.

Even though I am a value investor I have managed to avoid the value traps in recent years, other than a short foray into Hewlett Packard last year. In the past few months I have not been able to escape the side effects of the brutal bear market for value stocks. It has been a grueling experience and one I will not soon forget. It has reinforced the idea that one must account for all possibilities and make sure the portfolio can withstand it.


Joshua Heller said...

I am also long WLP and it hasn't been fun.  I thought when the entire mandate was held up WLP would rally 10% instead of down 10%.  13x seems high to me as revenue is declining.  Granted some of that decline is walking away from business where profits are too low or negative. 

I look at BV as being a margin of safety as well as continued stock buybacks and dividends.  The buybacks should increase EPS over time.  I was looking for $9.00 in EPS in 2014 with help from buybacks and a 10x multiple.  However with the recent decline in the stock price, WLP might be able to buy enough stock back to get earnings to $9.900 in 2013.

Tsachy Mishal said...

The group has historically traded at 13.5 times and WLP is the second largest HMO implying it should trade at the group multiple. They would likely need to show more consistent operating performance. Regardless of the multiple you plug in the share price should be far higher. Don't get me wrong, I would gladly sell at $95 in the next year.

The operating income derived from the business lines where the "free rider" problem exists is only 15% of total income. The market is acting as if Obamacare will completely bankrupt these companies.

Joshua Heller said...

I read in Barron's that the historical P/E for the industry was 13.5.  I believe the historical multiple is too high.  My observations in the marketplace has been that a stock when showing earnings growth in tandem with revenue growth, the market is willing to assign a higher PE.  I think the market perceives earnings growth from buybacks as lower quality and assigns a lower PE. 

WLP revenue growth is a combination of higher premiums (6-8%) with small subscriber losses (1-2%).  On the flip side is UNH which has both higher premiums and subscriber growth.  WLP trades at 8x this year's earnings estimates while UNH trades at 11.2x.  I think the best WLP shareholders like us can hope for is a move to 10-11x while UNH moves to 13.5x.   

I think one of the reasons the market is wrong (in this particular case) is because of low CapEx requirements as well as low R&D spending.  With WLP being a capital light business, the company can plow money into buybacks and dividends.  I joke to myself that one day I will own WLP as I will have the only shares left outstanding!

I also look at book value as margin of safety.  Looking (using Morningstar data) at book value from 2002, book value has increased 16% annualized on average.  Book value is currently at $66.95 and 16% per year would work for me if WLP traded at 1x book value going forward.