Add Humana for a Healthier Portfolio

In this article, let's take a look at Humana Inc. (HUM, Financial), a $19.29 billion market cap company, which provides a broad range of managed health care services to more than 12 million individuals.

Good Outlook

In 2012, more than 260 million people had health insurance coverage, according to the U.S. Census Bureau. We believe that managed care has good outlook among the Medicare and Medicaid populations.

The company has done a good job expanding its core MA and Medicaid businesses while achieving good levels of profitability. That expansion was successful as millions of Medicare recipients migrated to MA plans, in the last 10 years.

We know that the growth of MA products in part was the consequence of payment rates that were higher than the original Medicare. This will reverse in the future because the federal government tries to push rates down. We must say that more than a half its membership is tied to Medicare Advantage products.

The risks it faces are regulation, transparency and competition. When compared with its peers, we can say that the company is in a good position, but obviously greater transparency and competition will pressure prices down. A line deserves talking about the centralized costs, which the firm needs to control with discipline.

Finally, an older population in the U.S. is positive to Humana, because they increase the demand for health care and is expected to last for decades.

Revenues, Margins and Profitability

Looking at profitability, revenue grew by 18.41% and led earnings per share to increase in the most recent quarter compared to the same quarter a year ago ($2.19 vs $2.63). During the past fiscal year, the company increased its bottom line. It earned $7.70 versus $7.46 in the previous year. This year, Wall Street expects an improvement in earnings ($7.75 versus $7.70).

Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.

The company has a current ROE of 10.94% which is higher than the industry median and the ones exhibit by Universal American Corp. (UAM, Financial), Centene (CNC, Financial) and WellPoint (WLP, Financial). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, Cigna (CI, Financial) could be the option. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 18.8x, trading at a premium compared to an average of 17.9x for the industry. To use another metric, its price-to-book ratio of 1.93x indicates a discount versus the industry average of 2.04x while the price-to-sales ratio of 3.2x is above the industry average of 2.23x.

As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10,000 five years ago, today you could have $36,431, which represents a 29.5% compound annual growth rate (CAGR).

In the last year the share price has jumped by 34.02%.

Final Comment

The company´s expertise and recent past success in the MA market should impact during the next few years. This includes its experience with lower-profit plans that partially offset rising costs.

The PE relative valuation and the return on equity that significantly exceeds the industry average make me feel bullish on this stock.

Hedge fund gurus like Stanley Druckenmiller (Trades, Portfolio), Lee Ainslie (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), David Dreman (Trades, Portfolio) and Jeremy Grantham (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014, as well as Pioneer Investments (Trades, Portfolio).

Disclosure: Omar Venerio holds no position in any stocks mentioned