Here’s The Price I Would Buy Elevance Health Stock
[Elevance Health, Inc.(ELV)](/symbol/ELV?source=content_type%3Areact%7Csection%3Amain_content%7Csection_asset%3Ameta%7Cfirst_level_url%3Aarticle%7Csymbol%3AELV) (/symbol/HUM?source=content_type%3Areact%7Csection%3Amain_content%7Csection_asset%3Ameta%7Cfirst_level_url%3Aarticle%7Csymbol%3AHUM)
Summary
– After watching Elevance trend lower in recent months, I have re-evaluated the stock and updated the prices where I would become a buyer if I didn’t already own the stock.
– One of the factors I have included takes into account the possibility that the economy enters a recession and have accounted for this in my analysis.
– I have analyzed Elevance’s historical earnings pattern and current valuation, providing a 10-year earnings CAGR estimate and a recession P/E estimate for potential buy prices.
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Introduction
I always like to start my articles, when I can, by reviewing any previous coverage I’ve had of a stock.This can be useful because I tend to have a more quantitative investing approach that focuses on numbers in my articles rather than a story approach that focuses on a narrative.I first bought Elevance Health (NYSE:
ELV) back when it was called Anthem, for my Investing Group on 12/20/20, nearly three years ago.I produced a bullish YouTube video on the stock a few weeks later on 1/10/21, and it was a stock selection in a public Seeking Alpha article the next month on 2/11/21 titled ” There Are Bubbles Everywhere, But Cash Is Not The Place To Be, Here Are 10 Stocks To Buy Now”.
I went out of my way to warn investors about many of the popular market bubbles I saw at the time in early 2021.
There has been a lot of talk about bubbles in the marketplace lately, and bubbles certainly exist.Overall valuations of the stock market, by many accounts, are as expensive as they have ever been.Crypto-currencies like Bitcoin (
[BTC-USD]) have risen to uncharted territory.The IPO and SPAC market is on fire.
Residential real estate set new records in 2020.Bond yields are extremely low by most measures.I don’t think any of the above statements are particularly controversial.So, I suppose we shouldn’t be surprised to see discussions of bubbles becoming more frequent in the financial media.
Let’s say, for the sake of argument that all of the people claiming these markets are too expensive to invest in right now because they will produce very low or negative medium-to-long-term returns (say, over the course of 5-10 years) are right.(My nice way of saying, they are bubbles.) What should investors who wish to get a potential inflation-beating long-term CAGR from their investments do?
Perhaps we should first invert our thinking, and list what NOT to do if we want to achieve reasonably good long-term returns.In order to do that, we can think of things we should do if our goal is to produce poor long-term returns.
If you really want to ensure you will produce poor returns over the next decade you should 1) go out and buy as many recent IPOs and SPACs as you can, 2) buy lots of crypto-currency 3) put more than 20% of your portfolio in long-duration bonds 4) buy stocks with low earnings yields 5) buy stocks with PEG ratios over 3.0, 6) buy stocks taking on massive amounts of new debt just to keep their businesses alive, 7) buy stocks who had a temporary 2-year lift from COVID and are now trading at high prices, 8) buy a new house that you don’t need just because your stock portfolio has performed well, 9) buy the stocks of businesses that have shown evidence they are being disrupted by new technology, 10) own index or mutual funds that are heavily weighted with many of the above types of stocks, and last, but not least 11) hold lots of cash because you think everything is in a bubble.
Below is a sampling of some of the stocks and ETFs that fit into the categories I described above.
Only the homebuilders themselves have performed decently as demonstrated by Lennar (
LEN).Every other type of stock and long-term bond has performed poorly since then, and we haven’t even had a recession, yet.
Elevance has performed well, and I still own my position in spite of wider market weakness over the past several years.I reviewed the stock once last year in the article “
Elevance Health: Finding Boring Stocks That Make Money” and I rated it a Hold at the time.
Now that the stock price has shown some weakness even while earnings have risen, I thought it was a good time for another review where I share the price I would be willing to buy the stock if I didn’t own it already.In this article, I will take you through my updated investing process.
Elevance’s Historical Earnings Pattern
The first thing I always check when analyzing a stock is what the historical earnings pattern has been.
Earnings cyclicality is the main thing I check for, but I also look for other patterns like stagnation, unusual rises or declines, or erratic fluctuations that can’t be easily explained.If I determine the historical earnings are cyclical, then I usually don’t use earnings to value the stock because they can be too unpredictable and can often send the wrong signals regarding valuation.Also, if earnings are very erratic I sometimes immediately put the stock in the “too hard pile” if I don’t think historical earnings are a reasonably good guide for the future.
In the case of Elevance, earnings growth suffered a slight -1% decline during the Great Recession of 2008 but has grown every single year other than that one for the past 20 years.I would consider this a secular growth business based on earnings, which is a pretty rare designation.While secular growth never lasts forever, usually a business is doing something right if it can steadily grow earnings at a good rate for two decades without interruption.
At any rate, there is basically no earnings cyclicality here, so using an earnings-based analysis is appropriate for this business.
Elevance’s Current Valuation
This summer I’ve been adjusting my valuation method to account for three new factors that have grown more relevant in the past couple of years.Since I started using this valuation method in 2019, I have estimated about 1/3rd of the stock valuation by assuming the P/E of a steady-earning stock like Elevance would likely revert to its mean P/E over time.I have decided to do away with that portion of the analysis because I think with higher interest rates likely not going back to zero without a major recession, it’s unlikely most stocks maintain the average P/E ratios they had when interest rates were near 0%.
So, I will no longer include a mean reversion portion of my analysis and instead, I will only focus on the business earnings from the perspective of an owner of the business.
The other new factor relates to interest rates as well.In the past, I typically didn’t include a business’s debt and other obligations as part of my valuation process because interest rates were low so the cost of capital was low and didn’t appear to be likely to change during the last economic cycle.
Now rates have risen, so as time goes on and businesses need to refinance their debt over time, it’s likely to be a drag on future earnings.Conversely, businesses with net cash can actually earn a real rate on that cash, so they should be more valuable going forward.
In order to account for this, I now adjust the price of the stock (for valuation purposes) based on the total enterprise value of the business rather than market cap.
The third adjustment I’ve made is that I slightly altered the way I calculate “Recession Buy Prices” for stocks in order to determine the prices I aim to pay if I think the risk of recession is high, or if we are actually in a recession.I’ll explain more about this later in the article.For now, let’s get into the basic analysis.
10-Year Earnings CAGR Estimate
The most basic way I perform a valuation for a steady-earning stock like ELV is to calculate how much in earnings I would likely collect over a 10-year period if I owned the business and kept all the earnings for myself.I convert that amount of collected earnings into a CAGR percentage and use that percentage to decide whether or not the valuation is attractive.
I do this by using a combination of earnings yield and earnings growth expectations.I typically base my earnings growth expectations on what the growth rate has been over the previous cycle.In this case, I’m using a time period that runs from 2015-2023.
The first piece of information I need to estimate the 10-year business earnings CAGR is earnings, and typically I look at the current year’s analyst estimate because the market tends to be forward-looking.Right now analysts expect $32.91 per share this year (circled in gold on the FAST Graph).The second thing I want to take into account is debt or any other obligations the business might have, and adjust the stock price used for the valuation accordingly.The way I do this is to divide the Total Enterprise Value by the Market Cap (circled in purple) and when we do that we see the Total Enterprise Value is about 25% higher than the Market Cap.
The way I adjust for this in my valuation process is to assume that the stock price is about 25% higher than the price it is actually trading at.As I write this ELV is trading at $447.65, so I will treat it as though the price is really $559.56 per share.(This probably isn’t a perfect way to go about doing this, but I track and cover a lot of stocks so I try to have practical processes that I can use quickly while still being relatively effective in arriving at a good ballpark valuation.)
When I do this, I get a debt-adjusted earnings yield of about +5.88%.
Next, I want to estimate how fast those earnings are likely to grow over time, and in order to do that I look at how fast those earnings have been growing, year-by-year since 2015 while controlling for buybacks (because buybacks will inflate earnings per share).
Elevance has bought back about 12% of the company since 2015.After making adjustments for those I get an earnings growth rate of about +14.11%, which is a very good earnings growth rate (yet a little more conservative than FAST Graphs’ +15.71% rate because I accounted for buybacks).
Next, I’ll apply that growth rate to current earnings, looking forward 10 years in order to get a final 10-year CAGR estimate.The way I think about this is, if I bought ELV’s whole business for $100, it would pay me back $5.88 plus +14.11% growth the first year, and that amount would grow at +14.11% per year for 10 years after that.I want to know how much money I would have in total at the end of 10 years on my $100 investment, which I calculate to be about $230.53 (including the original $100).
When I plug that growth into a CAGR calculator, that translates to a +8.71% 10-year CAGR estimate for the expected business earnings returns after adjusting for debt and other obligations.
10-Year, Full-Cycle CAGR Estimate
Using my old valuation method, which included a mean reversion factor and did not take debt into account, I used a “Hold Range” for the 10-Year CAGR between 4% and 12%, and if it was below 4% the stock would usually be a “Sell”, and above 12% a “Buy”.Now that I have removed the P/E mean reversion part of the estimate I’ve tightened the “Hold” range from 5% to 8% because there is typically a lot less fluctuation when it comes to average business earnings than there is with the stock price.The current +8.71% 10-year estimated business CAGR would, under normal circumstances, make ELV a “Buy”.However, I think recession risk in the near term is high right now, so I have a stricter standard in place for the time being that takes recession risk into account.
Recession P/E
Since January of 2022, I’ve been adjusting my portfolio and preparing for a stimulus boom/bust and a likely recession.While most of the stimulus money bust has happened and that’s why the market experienced a bear market last year, due to lots of excess savings, a delay in student loan repayments, and lagged effects of higher interest rates, thus far we haven’t had an economic recession.I think over the next 6-9 months recession risk in the US remains high, though, so I am using stricter standards for new stock purchases.
One of the techniques I use to try to get lower prices and avoid paying too much near economic peaks is what I call the Recession P/E, a variation of which I used during the pandemic in 2020 with great success.
I’ve made a few adjustments to the technique since then, and I’ll share those here.
For the record, I still own ELV from when I bought it in late 2020, so what I’m sharing here is how I would determine my buy price if I didn’t already own it.
It’s similar to what I’m using with Humana (
HUM) right now, which I don’t currently own.
The thought process with the Recession P/E is to try to find the most pessimistic P/E the stock experienced in the past and to then be prepared to buy the stock when it is within a certain range of peak pessimism.For example, if the most pessimistic P/E the stock experienced during a previous downturn or recession was, say a 10 P/E, then I might be willing to buy a stock if the current Recession P/E was within 30% of a 10 P/E, or a 13 P/E.So, we aren’t trying to pick an exact bottom in the price, mostly what we are trying to do is use peak earnings to current price as a more stable guide to estimating how low a stock might fall for a given stock during a recession when current and forward earnings are fluctuating a lot (and tend to go from very optimistic to very pessimistic).This is most useful for moderately cyclical stocks, which ELV is not, but it can also be useful for stocks that go through negative sentiment periods, which health insurers certainly do.
The way this works is I look at the business’s history during a downturn and I take the lowest price the stock fell to and create a ratio using the peak annual earnings per share the business experienced.
That is the “Recession P/E”.I use my judgment regarding which historical downturn is most likely to repeat in the future.In ELV’s case, because many people thought the government might take over the entire healthcare industry in 2009, the Recession P/E was abnormally low, so I am using 2020’s March decline for this Recession P/E estimate.
The low stock price in March 2020 was $171.03 per share and EPS for 2019 was $19.44, which is a Recession P/E of 8.80.(This tends to be much more useful for businesses that have rapidly falling earnings (like, say, Target (
TGT) recently) than one where earnings are steady, but we can see that the market often doesn’t care about only the earnings and will get spooked about other things as well.) In ELV’s case, I would be willing to buy if it got within 40% of an 8.80 recession P/E, which is a P/E of 12.32, adjusted for debt, about 9.88.
I have their current debt-adjusted P/E at about 13.53, so it is not quite down to the price it needs to be to buy right now if a person thinks a recession is a high probability.I currently have that buy price at $324.36, which is about -27% lower than today’s price.Investors who buy around that price should have a high probability of above-average long-term returns.And, importantly, if there is a recession, there is a very good chance (better than 50%) that price hits.
Conclusion
Whether Elevance stock is a good buy right now mostly depends on how much recession risk there is in the wider economy.I think the recession risk is pretty high, so if I was looking for an entry point over the next few months, I think under about $325 per share is where I would aim.If a person doesn’t think a recession within the next year or so is likely, then Elevance is a good buy right now.The average expected 10-year business earnings CAGR for the S&P 500 I estimate is about 5% to 5.5%, while Elevance at today’s price is more like 8% to 9% if the earnings trends since 2015 continue.Perhaps Elevance won’t be able to grow at those kinds of rates going forward, I don’t have a reliable way to know that, but it has a good track record and decent margin of safety compared to the wider market right now.
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This article was written by
My analysis focuses on the cyclical nature of individual companies and of markets in general.I’ve developed a unique approach to estimating the fair value of cyclical stocks, and that approach allows me to more accurately buy near the bottom of the cycle.
My academic background is in political science and I hold a Bachelor’s Degree and a Master’s Degree in political theory from Iowa State University.
I was awarded a Graduate Research Excellence Award in 2015 for my research on conservatism.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of ELV either through stock ownership, options, or other derivatives.I wrote this article myself, and it expresses my own opinions.I am not receiving compensation for it (other than from Seeking Alpha).I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha’s Disclosure: Past performance is no guarantee of future results.No recommendation or advice is being given as to whether any investment is suitable for a particular investor.
Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole.Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank.Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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