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UnitedHealth Stock: Analysts See 21% Upside Potential
Stock Analysis & Ideas

UnitedHealth Stock: Analysts See 21% Upside Potential

UnitedHealth Group (UNH) is a diversified healthcare company offering healthcare coverage and benefits services through UnitedHealthcare and information and technology-enabled health services through Optum.

UNH is a fundamentally solid and predictable company with solid upside potential. As a result, we are bullish on the stock.

UnitedHealth’s Competitive Advantage

UNH is one of the largest companies in the world. It got to this level because it has an edge over its competitors. There are a couple of ways to quantify a company’s competitive advantage using only its income statement. The first method involves calculating earnings power value (EPV).

Earnings power value is measured as adjusted EBIT after tax, divided by the weighted average cost of capital, and reproduction value (the cost to reproduce the business) can be measured using a company’s total asset value. If the earnings power value is higher than the reproduction value, then a company is considered to have a competitive advantage.

For UnitedHealth, the calculation is as follows:

EPV = EPV adjusted earnings / WACC
$375 billion = $25.5 billion / 0.068

Since UnitedHealth Group has a total asset value of $221.2 billion, we can say that it does have a competitive advantage. In other words, assuming no growth for UnitedHealth Group, it would require $221.2 billion of assets to generate $375 billion in value over time.

The second method to determine a competitive advantage is by looking at a company’s gross margin because it represents the premium that consumers are willing to pay over the cost of a product or service. An expanding gross margin indicates that a sustainable competitive advantage is present.

When companies have no edge, new entrants eventually take away market share, leading to decreasing gross margins as pricing wars ensue to remain competitive.

In UnitedHealth Group’s case, its gross margin has remained relatively flat in the past several years, ranging from 23.6% to 26.1% in the past six years. As a result, its gross margin indicates that a competitive advantage is present in this regard as well.

DuPont Analysis

When taking a look at UNH’s return on equity, we can see that the trend has been flat. Stocks with a high return on equity tend to outperform the market, which is why it is an important metric to watch.

The company’s return on equity trend is as follows:

Image created by the author

This would suggest that UNH is efficient at using its capital. However, let’s take a deeper look at just how efficient the company truly is. When breaking down the ROE trend into a DuPont analysis, we can separate it into three different parts.

The first part is the profit margin, which measures what percentage of revenue the company keeps as profit. The second part is asset turnover, which measures how efficiently a company uses its assets to generate revenue. Lastly, we arrive at the equity multiplier to measure how much leverage the company uses.

By multiplying all three metrics together, we arrive at ROE. The DuPont analysis is useful because it helps management and investors determine the key drivers of return on equity. It also allows managers to address issues such as too much leverage or an inefficient use of assets.

For UNH, the breakdown of ROE is as follows:

Image created by the author

As we can see, the trend has remained very steady over the past several years. This suggests that the company is reasonably predictable and reliably profitable under many different market conditions.

Dividend

For investors that like dividends, UnitedHealth Group currently has a 1.16% dividend yield, which is below the sector average of 1.35%. When taking a look at its payout ratio of 30.2%, its dividend payment looks safe.

Taking a look at its historical dividend payments, we can see that its yield range has trended downwards in the past several years.

At 1.16%, the company’s dividend is near the lower end of its range, implying that the stock price is trading at a premium relative to the yields investors have seen in the past.

As a result, it’s probably not the best stock for income investors because they would be better off investing in U.S. Treasuries that yield near 3%.

Risks

To measure UnitedHealth Group’s risk, we will first check whether financial leverage is an issue. We do this by comparing its debt-to-free cash flow. Currently, this number stands at 2.5.

Overall, we don’t believe that debt is currently a material risk for the company because its interest coverage ratio is 14.3 (calculated as EBIT divided by interest expense). This means that it can cover its annual interest payments 14.3 times over using its operating earnings.

However, there are other risks associated with the company. According to Tipranks’ Risk Analysis, United Health has disclosed 20 risks in its most recent earnings report. The highest amount of risk came from the Legal & Regulatory category.

The total number of risks has increased over time, as shown in the picture below.

Wall Street’s Take

Turning to Wall Street, UnitedHealth Group has a Strong Buy consensus rating based on 15 Buys, three Holds, and zero Sells assigned in the past three months. The average UnitedHealth Group price target of $590.35 implies 21.4% upside potential.

Final Thoughts

UnitedHealth is a strong business with a measurable competitive advantage and backing from the analyst community. In addition, it is reasonably predictable and reliably profitable in all economic conditions. As a result, we are bullish on the stock.

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