(Editor's note: A version of this article appeared in
optionMONSTER's Open Order newsletter of May 4.
One of the most striking developments this earnings season is the
jaw-dropping strength of health-insurance companies such as
UnitedHealth Group, Aetna, and Humana.
UNH was expected to report profit of $0.89 a share but thrashed
that number with net income of $1.22. Revenue was also well above
AET was even more impressive because its top line beat by a much
narrower margin, while its bottom-line profit of $1.50 crushed the
$0.96 estimate. That reflects a massive surge in profitability that
no one expected.
HUM reported similarly strong results, and guidance from all three
companies was significantly above forecasts.
Several factors are driving this strength. One is that people are
using medical services less: UNH and AET paid out 81.4 percent and
79.2 percent of premiums received in claims, respectively, which is
1 to 1.5 percentage points lower than the levels of 2006 and 2007.
Most readers have probably seen evidence of this in their own lives
as co-payments have increased, discouraging visits to the doctor.
Or perhaps you had to get interviewed by third-party before the
insurer pays for a test like an MRI.
Income stagnation is another factor because a lot of health-care
spending is discretionary: Joe Six-Pack hasn't had a raise in four
years, and gasoline prices are killing him. He would like to see a
knee doctor, but his out-of-pocket cost for the specialist just
doubled. So he simply forgoes the care and lives with the pain.
In fact, we seem to be in the early stages of a new secular trend
where health-care costs no longer run ahead of broader inflation.
Monthly inflation data show that non-seasonally adjusted prices
rose 0.98 percent for all items between February and March, the
fastest gain since June 2006. There were also strong readings in
January and February versus negligible changes throughout 2009 and
But in the category of health-care services, the opposite is
happening. Prices increased just 0.1 percent, following a
moderation of prices in the preceding 12 months. Health-care
inflation averaged roughly twice the overall rate between 1980 and
about 2005, so it's clearly slowing compared with the broader
It's still a little early, but I will go out on a limb. As I have
discussed in previous columns, I like to take a thesis that seems
to be true, then try to ride stocks that manifest it. We won't know
if it's correct until most of the money has been made, but the
price action and earnings will give us a pretty good idea if we're
The new trend we're seeing is dramatic innovation in health care,
an industry that has been fat and lazy for years. While sectors
from retail to finance have experienced massive cost reductions,
most doctors' offices are at somewhere back in the 1950s (if not
the 1850s), clogged with paperwork, redundant processes, and
uncountable instances of waste. This is where companies such as
Cerner and McKesson are stepping in.
The consumers of health care--ordinary people plus state and local
governments--are more squeezed financially than ever before. On top
of that, you have baby boomers needing record amounts of cheap,
All of this offers huge opportunities for greater efficiency and
wealth creation, so look for companies that will benefit from this
massive change. (Pharmacy-benefit companies such as MedcoHealth
Solutions and Express Scripts have also done so by cutting drug
Trust the charts and earnings more than analysts or the media, and
don't fall in love with any one stock. It's better to have a broad
familiarity with many names and a limited commitment than a deep
knowledge of one or two companies and a major commitment to them.
(Chart courtesy of tradeMONSTER)
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