Universal Health Services stock is a buy: Here’s why (NYSE: UHS)

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Ninoon

Build a portfolio based on valuation

Valuation always matters. In fact, some say we appreciate investors who make our money when we buy, not when we sell. Why? Because buying at favorable price levels gives us a chance to enjoy the benefits of the company growth over longer periods.

The reverse is also true: Buyers of stocks at inflated valuation levels can expect future disappointment as the price may languish.

The long-term idea is to make stock picks based on some version of valuation: what is the value the penalty? One way to patiently build a growing portfolio is to buy when stocks are below their own normalized valuation and be prepared to exit stocks when valuations are stretched.

The trick is to buy grim news – and be patient

For us to profit from improving business, we must be willing to buy when the news is gloomy and the price reflects bad news. Of course, this requires the ability to go against the crowd.

The second requirement is patience, meaning the willingness to buy and hold for reasonable periods as the business responds to the environment and conditions improve. For long-term value investors, that means patient holding periods measured in months and years, not hours, days or weeks.

What to expect from this article

This article presents the universal health services (NYSE: UHS) as an attractive candidate in the field of health services. The company has a history of growing fundamentals and the stock price is currently favorable based on the company’s own history.

The article outlines UHS’ year-to-date performance, several reasons why the stock price is depressed, catalysts for future improvement, and a valuation model suggesting the stock is currently attractive. Finally, the estimated 5-year upside and downside risk are split for your consideration.

Company Quick Profile

Universal Health Services owns and operates acute care and surgical hospitals, behavioral health centers, and surgical/radiation oncology centers. The company operates 40 outpatient care facilities and 363 inpatient centers in 39 states.

With a market capitalization of $7.7 billion and 89,000 employees, the company operates in the healthcare sector and medical facilities industry. The S&P rating is BB+.

Year-to-date stock price underperformance

UHS has been beaten as shares have sold off sharply since the start of the year on bad news and overall downward market pressure. As you can see in the summary below, the healthcare sector is down 11.3% year-to-date.

sector performance since the beginning of the year

Year-to-date sector performance (SeekingAlpha)

UHS stock price, however, significantly underperformed the sector with a 27% selloff.

UHS share price year-to-date

UHS stock price year-to-date (Yahoo! Finance)

Is this price drop an opportunity for patient value investors, or a trap? To get started, let’s explore several reasons for stock selling, as well as possible catalysts for improvement.

Reasons why the stock price is falling

Simply put, the forecast predicts pressure on EPS and continued headwinds on earnings. Although revenues have increased over last year, labor costs and other operating expenses will continue to hurt profits. Employment contracts and rising payroll taxes and difficulties recruiting and retaining quality staff will ease is a key driver, and additional operating costs to deal with Covid-19 are expected. Management expects these pressures to continue through perhaps 2023 before easing.

Catalysts for future improvement

Three factors will likely improve the picture: First, aggressive cost-cutting efforts are underway through contract negotiations with third-party payers. Second, the company seeks additional operational efficiencies to make work more efficient and maximize labor productivity. Finally, Covid-related impacts are expected to slowly fade over the next 12-18 months, which should improve earnings.

The relationship between earnings and stock price

To build a long-term portfolio, the approach is simple: valuation, valuation, valuation. The idea is to compare the relationship between earnings and share price over long periods of time, then apply a normalized price-to-earnings ratio to derive a valuation.

See the table below. The orange line represents long-term earnings growth and the black line represents the corresponding stock price.

We can see that UHS has a history of earnings growth over long periods, as EPS has grown at a rate of just over 10%.

Also note that the stock price has started to reach levels not seen since the Covid lows.

UHS Prices and Revenues

UHS Earnings and Stock Price Comparison (FastGraphs)

What are UHS shares worth?

Historically, UHS has a normalized price-to-earnings ratio (PE ratio) of 13.3X earnings. Today, stocks are available for less than 10X.

If we apply the normalized 13.3X to the expected earnings per share, it is reasonable to reach a valuation of around $133 over the next year.

This estimate is well illustrated on the chart below, as the blue line represents the normal PE and the black line is the stock price.

UHS Rating

Estimated Rating (FastGraphs)

With a stock price around $96, is a $133 valuation outrageous? Well, it’s true that the general health news is grim right now. But note that the stock price has hit highs well above $133 each of the past 5 years – on earnings well below today’s estimates.

Risk and Reward – An Estimate

It is important to know what to expect from any stock we buy. In order to understand the potential range of the stock price over the next 5 years, one method is to apply a “high” PE multiple and a normalized 5-year “high” PE multiple to the high and low EPS forecasts. expected.

When we apply a high 5-year average PE of 15.8X to the high estimated earnings, this suggests a high-end stock price of $221 over the next 60 months. At the same time, when we apply a low 5-year average PE of 10.3X, then $87 could be a low stock price.

My chart below is ugly, but it’s useful to see a reasonable possible range going forward. At least we’re getting a rational, numbers-based estimate of what to expect.

UHS top and bottom

UHS high and low estimates (Bigcharts; author’s notes)

Final Thoughts

UHS is a quality company with a history of growing fundamentals. The healthcare space is bleak at the moment, with revenues under pressure due to Covid-related staffing costs and operational expenses. The current price/earnings relationship is favourable, and investors looking for long-term value may be well served to start a position at these levels. Your account will probably thank you in the future.

Thank you for taking the time to read this article.

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