Like a lot of investors, I have learned more about the stock market by studying Warren Buffett and the buys he makes than from all the “financial media” in the world. Perhaps the most important lesson that Uncle Warren can teach investors is the attributes of a money-making stock, and I think I have discovered an equity that meets those criteria: UnitedHealth Group (NYSE: UNH).
My interest in this health insurer was piqued when I went to Colorado’s Obamacare exchange, Connect for Colorado, to shop for health insurance for next year. I noticed that there were only two brands of health insurance available in my area through the exchange: UnitedHealth and Anthem (NYSE: ANTM). That indicates a classic Buffett stock attribute —a wide moat – which is characterized by little competition and a high cost of entry into the market.
The moat in health insurance is very wide, and it is getting wider. The largest plan offered on the Colorado exchange, Colorado HealthOP, has been shut down because it ran out of money. That means less competition and a wider moat for UnitedHealth. That situation is being repeated in a number of states, including Kentucky, Nevada, New York, Nebraska, Iowa, Oregon and Tennessee.
This brings me to another lesson I learned from Uncle Warren: Look around before you buy a stock, and try to find something that everybody is using. UnitedHealth Group certainly qualifies; I’ve used their plans before, and there’s a good chance I’ll have their insurance card in my wallet next year.
Why UnitedHealth Qualifies as a Value Investment
UnitedHealth meets a number of other Buffett criteria, including the fact that it is an insurance company, a business Uncle Warren loves. Like many insurers, UnitedHealth has a lot of float because of all the premiums it collects.
Its business model is made all the better by Obamacare, which requires Americans to get health insurance or pay higher taxes. Obamacare also provides tax credits to help Americans buy that insurance, and it mandates that businesses that employ more than 50 people buy coverage for their employees.
The financial numbers indicate that float is generating a lot of cash at UnitedHealth. On September 30, 2015, UnitedHealth reported some very impressive financials for the third quarter of 2015, including:
- Cash and short-term investments of $9.925 billion.
- A net income of $6.105 billion.
- $8.658 billion in cash from operations.
- A free cash flow of $2.441 billion.
- A TTM revenue of $146.94 billion.
What is more important is that UnitedHealth is growing at an incredible rate, largely because of Obamacare. Its revenue grew by $18.78 billion over the past year. In September 2014 UnitedHealth reported a TTM revenue of $128.16 billion, which increased to $146.94 billion over the next 12 months.
Why UHG Is a Better Stock Than Amazon
This makes UnitedHealth one of the fastest-growing companies in America. Its level of growth actually exceeds that of market favorite Amazon.com (NASDAQ: AMZN), without the high stock price. For the record, Amazon’s revenues increased by $15.24 billion between September 2014 and September 2015, rising from $85.25 billion to $100.59 billion. UnitedHealth was able to produce that kind of revenue growth without the massive infrastructure spending at Amazon.
This brings us to another classic value attribute that UnitedHealth has: It is not sexy or glamorous. UnitedHealth operates in a very boring business that many people find distasteful. That attracts little attention, but it makes a lot of money.
Another attribute UnitedHealth has is that it is a very simple business that an idiot could run. It collects premiums from policyholders and pays claims. That’s another of Warren’s most popular lessons: Invest in companies so simple an idiot can run them because chances are sooner or later there will be a moron in the executive suite.
Beyond the existential reasons, UnitedHealth is just a good basic stock. It gave investors a dividend yield of 1.51% and a return on equity of 18.71% on September 30. In contrast, Amazon paid no dividend and offered investors a return on equity of 2.92% on a stock that was trading at $657.02 a share on November 10, 2015.
Why UnitedHealth Group Is Underpriced
UnitedHealth is also a very underpriced stock even though it was trading at $115.69 a share on November 10, 2015. The company had a market capitalization of $110.27 billion and an enterprise value of $130.77 billion on that day.
The main reason UnitedHealth is undervalued is that its revenues are about to increase dramatically because its competitors in states like Colorado are disappearing, as I noted above. Several competing health plans around the country have shut down, leaving UnitedHealth and Anthem the only options in a number of states.
My prediction is that we will probably see a major increase in UnitedHealth and possibly Anthem’s revenue next year as they pick up large numbers of new policyholders through the exchanges. Sooner or later, Mr. Market will notice that, and UnitedHealth’s stock value will go up.
A Potential Threat to UnitedHealth’s Future
Even though it is a value stock, UnitedHealth faces a very uncertain future because of the nature of its business. This company’s growth is being driven by a regulatory environment that stifles competition and effectively forces people to buy its products or take jobs where employers pay for them. It also enjoys the luxury of having Uncle Sam underwrite the cost of some of its premiums.
The danger here is that the regulatory environment could change at any time because of politics. Much of UnitedHealth’s success comes from Obamacare, which is politically unpopular. One major political party, the Republicans, is totally hostile to the program, and many Republican politicians, including most of the presidential candidates, are running on promises to dismantle it.
A successful Republican assault on Obamacare is unlikely because that party is in disarray, but the program is also under serious attack from the left. The second most successful Democratic presidential candidate, Bernie Sanders, is a notable advocate of government-financed, single-payer health insurance, which would effectively eliminate UnitedHealth’s business. The Democratic front runner; Hillary Clinton, has been a prominent advocate of single-payer health insurance in the past—remember Hillary Care?
More dangerous still is the political climate in states like Colorado, where Obamacare is failing to deliver on its promises. Around 156,000 Coloradoans signed petitions to get Initiative 20, a measure that would create a state-administered, single-payer health insurance plan, on the state ballot for 2016. That issue could set a precedent for other states with ballot initiatives, such as California.
The political climate, which is driven partially by deep dissatisfaction with the economy, seems to be against health insurance companies. That means it is likely that UnitedHealth’s business could disappear in the next few years. Despite that, this is still a very good stock that has many of the attributes of a classic Buffett value play.