By almost any valuation metric, HealthSpring Inc. (NYSE: HS) appears to be undervalued. It trades with a P/E under 5, and a P/B value of .7. As a managed health care organization targetting seniors, revenues and earnings have been fairly stable over the last several years.
In addition, the company has more cash than it does long term debt. For a company in such a stable industry, it is surprising to see such a conservative capital structure.
Nevertheless, there is no shortage of risks to this company. Investors who rely solely on the numbers will often miss many of the risks that have the potential to derail the outstanding returns that a stock may offer. Investors who understand the risks, however, are more likely to be able to make a more accurate determination as to whether the upside potential outweighs the risks.
Most of a company's risks can be gleaned off conference calls (as management discusses some of the most important challenges facing the business), or can be found explicitly in the annual reports. Some of the risks for HealthSpring include:
- Heath care inflation. Margins are being squeezed as revenues are not rising as fast as costs. Who knows how long this situation will persist.
- Government regulation. This is a major issue with most managed care companies. Complying with ever-changing standards and dealing with enforcement agencies is a cost that is hurting many competitors, and HS is not likely to be immune.
- Reliance on Medicare. With service rates set annually by the Centers for Medicare and Medicaid Services (CMS), HS can be caught off-guard by rate changes that are not in line with the costs. For example, 2010 CMS benchmark rates were brought down by around 5% based on the types of care HS provides.
All that being said, the above risks don't neccessariliy mean the stock doesn't offer great upside potential. However, all investments should lie within a value investor's circle of competence. Those who limit their investments to this restricted subset of the stock universe should be able to achieve better returns through superior stock selection.
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