On recent travels, I’ve been doing some thinking on the overall valuation of the domestic market – alongside reading a few differentiated thoughts on the matter. I don’t want to go as far as saying that investors need to be discounting a revolutionary change in the economy from artificial intelligence (“A.I.”) that renders the old rules useless. AI could indeed be a long-term positive for the economy that will usher in a step-function boom in productivity. But let’s think through this a bit more simplistically.
What if there has been a foundational change in what the absolute level in which the market will be priced at moving into the future? To me, it can sometimes feel like the market is always over-valued. Back in the 2000s, many investors thought that 13x earnings was wildly overpriced – we’re 50% higher than that now. Even as recently as 2015, some stock pickers wouldn’t even touch a stock greater than 18x forward earnings. Look at us now!
Over the last few decades, there has been an increased usage of diversification, which could make investors understand that they need to accept higher valuations, given ease of access to information and relative times savings. The best analogy that I have heard regarding this is: Imagine that you’re an investor in the 1930s/1940s and you wanted diversification. You’d have to buy mutual funds that has exuberant fee loads of like 7% – 9% (plus annual mgmt. fees). And, if you didn’t want to realize those fees, investors could do the work themselves. But that requires time and would be an even more difficult task to execute on, given the lack of access to information. Not to mention the time necessary to manage those holdings after time of purchase.
Then, imagine the unknown in the market after the Great Depression – the worst economic crisis in our history – without easy access to information, it would have been very difficult to make a well-informed decision on if one should stay invested. Today, it feels like investors have just kept buying … “just because”. Investing today is far simpler and cheaper that it was nearly a century ago…and that’s just the new cost of investing that has demanded a higher multiple relative to before.
Now, I’m not going to say that this market isn’t expensive, as I think that it’s saying more that investors may need to tread lightly at this level. What I am trying to say is that valuation is just another arrow in one’s quiver – it shouldn’t be the sole rationale as to why one should not currently invest. Remember, using valuation as a short-term timing tool is a fool’s errand. As the market changes, investors must also change, or they could quickly become a sacrificial lamb.
Now, let’s talk UNH – luckily, we believe that their valuation is very palatable.
UNH Case Study
UnitedHealth Group, Inc. (UNH):
What Do They Do?: UnitedHealth Group, the largest private health insurer in the U.S., provides a diverse and comprehensive array of health and well-being services to people through all stages of life. The company provides medical benefits to over 50 million members through employer-sponsored, self-directed, and government-backed insurance plans in the U.S. and internationally. UnitedHealth has two operating units: UnitedHealthcare (77% of Revenue) and Optum (23% of Revenue).
Overall Thesis: We remain convicted on UNH due to an attractive valuation, potential for hardening pricing in 2024, and attractive LT growth in value-based care. As I wrote about in our Aptus Compounders Halftime Report – 1H ’23, time is one of our best assets. Going back a year, we liked the UNH story, but were not too enthusiastic about its valuation. But, when you own for longer periods of time, you have to deal with the ebbs and flow of valuation as you let your capital compound for you. Yet, today, we don’t just like the valuation of UNH, we love it. About 12 months ago, the stock traded at a 30% premium to the market, now it trades at a 10% discount. With the stock down ~3% YTD and valuation down to 0.9x of SPX, we believe most of the associated uncertainty regarding medical costs are priced in. We believe UNH is a best-in-class managed care organization (“MCO”) and value-based care (“VBC”) company, and current valuation offers a unique opportunity to buy a piece of a business with a large runway of growth in front of it at very attractive valuation.
Yield + Growth Frameworks:
Dividend Yield: 1.48%
Growth Rate: 12.00%
Y + G = 13.48%
I’m deriving our growth rate from the following information:
1. Optum: We see gov’t MCO and OptumCare as strong growth pillars for UNH and are interested in what will emerge over the next 5-10 years as their 3rd pillar of their business model. Given their HC system technology, UNH’s management expects 13-16% LT EPS growth targets for Optum.
2. United HealthCare: Health care spending has grown consistently for many years and comprises approximately 18% of U.S. GDP. This trend is likely to continue as baby boomers continue to age. With this, I’d expect this segment to grow at a healthy rate.
The Valuation: UNH relative valuation at 0.9x is very attractive relative to historic levels. We believe that investors could see the stock trading at 1.1x – 1.2x for UNH, and view 1.2x as a normal high-end of historic relative valuations. During ’22, we saw valuations getting as high as 1.4x, which we felt were stretched. The current 0.9x is very attractive to us, near “Medicare for All” lows of 0.85x. We believe long term UNH will trade at 1.1 to 1.2x the market, presenting further upside.
The Wildcard: UNH typically derives ~1/3rd of its growth from M&A, of which, they have a great track record – we’ll see what happens with Amedysis (AMED), which is coincidentally one of the largest competitors to Chemed Corp.’s (CHE) subsidiary, Vitas – which is held in the Aptus Compounders portfolio.
UNH did a great job growing Optum, which diversified its business from UnitedHealth, but we believe that management will start looking for a third leg to the stool with another large, transformational acquisition. We’d assume that they are looking for a high growth business to complement its VBC and government MCO businesses. We believe UNH is developing growth engines in health system enablement and consumerism. We believe the health system enablement strategy should present an explosive opportunity leveraging AI and care automation to revolutionize the costs of care delivery.
In its current form, OptumInsights is focused on incremental health system enablement, in areas like revenue cycle management and efficiencies. UNH is positioned to assist health systems in the transition to VBC by enabling the taking and managing of clinical risk, leveraging its OptumHealth and UHC capabilities. The biggest long-term opportunity though is the leverage of digital and AI to expand the supply of care delivery to reduce costs and expand volume for health systems. While many will target this opportunity, UNH is well positioned given its capabilities and existing role with health systems.
Technical Thoughts: UNH – Since the end of 2021, UNH has essentially gone nowhere. It was up in 2022 while most things were down and has severely underperformed the broader indices and its sector YTD. But, through all that, it’s also found a nice base in the $450-$500 range, and recently exhibited a “double bottom” support move off of $450 with higher volume pushing it above $500. While not exactly saying “full steam ahead”, it’s arguable that it’s found a low and should compound higher over the medium- to long-term from here. Targets are pretty obvious @ $550 and a breakout there would see it easily clearing $600 and beyond after making this 1.5 year base / consolidation move around $450. Could be a multi-year upside move once it gets started.
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