A Cure for Summertime Blues

06/23/2010 4:40 pm EST


John Reese

Founder and CEO, Validea.com And Validea Capital Management

John Reese, editor of Validea Hot List, breaks down a Medicare provider delivering strong growth at a bargain price.

Another Hot List holding that has characteristics traditionally associated with both growth and value stocks is HealthSpring (NYSE: HS), a niche healthcare firm that specializes in Medicare Advantage offerings. HealthSpring has growing earnings quite rapidly—it has upped EPS in each of the past four years and seven of the past eight, and over the long term is growing earnings at a 46% clip. But it's also a bargain, as investors leery of the healthcare bill's Medicare cutbacks have been avoiding this proven performer. It sells for just 6.3 times trailing 12-month earnings, 0.34 times sales, and 0.99 times book value.

HealthSpring is a managed care organization with a primary focus on Medicare, the federal government-sponsored health insurance program. As of December 31st, 2009, the company operated coordinated care Medicare Advantage plans in Alabama, Florida, Illinois, Mississippi, Tennessee, and Texas. As of January 1st, 2010, it also commenced operations of Medicare Advantage plans in three counties in Northern Georgia. As of December 31st, 2009, the company's Medicare Advantage plans had over 189,000 members. The company also offers prescription drug benefits in accordance with Medicare Part D to its Medicare Advantage plan members, in addition to providing other medical benefits (MA-PD) plans. It also offers prescription drug benefits nationally on a stand-alone basis in accordance with Medicare Part D (PDP).

[The Growth Investor strategy, based on the work of noted value investor Martin Zweig, dictates that] the P/E of a company must be greater than five to eliminate weak companies, but not more than three times the current market P/E because the situation is much too risky, and never greater than 43. HS's price/earnings is 6.39, based on trailing 12-month earnings, while the current market price/earnings is 13. Therefore, it passes the first test.

Revenue growth must not be substantially less than earnings growth. For earnings to continue to grow over time they must be supported by a comparable or better sales growth rate and not just by cost cutting or other non-sales measures. HS's revenue growth is 31.35%, while it's earnings growth rate is 46.12%, based on the average of the 3-, 4-, and 5-year historical growth rates. Sales growth is not at least 85% of EPS growth so the initial part of this criteria is not met, however, since both sales growth and eps growth are greater than 30%, that requirement is waived and the company passes this test.

Companies must show persistent yearly earnings growth. To fulfill this requirement a company's earnings must increase each year for a five year period. HS, whose annual EPS growth before extraordinary items for the previous five years (from the earliest to the most recent fiscal year) were 0.24, 1.44, 1.51, 2.12, and 2.41, passes this test.

One final earnings test required is that the long-term earnings growth rate must be at least 15% per year. HS's long-term growth rate of 46.12%, based on the average of the 3-, 4-, and 5-year historical eps growth rates, passes this test.

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