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Why Vanguard Health Systems Shares Sank

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Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Vanguard Health Systems (UNKNOWN: VHS.DL  ) , which owns acute care centers and hospitals, dipped as much as 15% after the company was notified by the state of Arizona that it was not going to be awarded a Medicaid-care contract in the upcoming year beginning this October.

So what: With the Affordable Care Act about to make the Medicaid contract market considerably more competitive from a pricing perspective, Vanguard's loss is clearly a negative. However, research firm Cantor Fitzgerald came to Vanguard's aid by noting that the loss of this Medicaid contract wasn't a huge deal since the majority of the company's revenue is generated in hospitals and not Medicaid-reimbursed facilities.

Now what: My usual rule is that one loss is an aberration, but another Medicaid contract lost would be the start of a nasty trend. At the moment I'd worry less about the Medicaid contract and more about Vanguard's frothy valuation, which has it trading at 15 times forward earnings. Yes, hospital operators are going to receive a nice boost from the ACA with a majority of their doubtful provisions disappearing, but that still may not justify this high of a valuation on Vanguard, whose revenue growth may be close to flat on a year-over-year basis in 2014.

Craving more input? Start by adding Vanguard Health Systems to your free and personalized watchlist so you can keep up on the latest news with the company.

While you can certainly make huge gains in hospital operators like Vanguard Health Systems, the best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

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