Investors are seeing plenty of reasons to consider buying stock in health insurers such as WellPoint (ELV 0.13%). Better than hoped enrollment in health insurance under the Affordable Care Act, Medicaid expansion, and Medicare Advantage demand are all driving sales higher.
But that may not mean that it's the right time to buy for investors who don't already own shares. Any number of developments can drive share prices lower, especially in regulated industries such as insurance. So let's look at WellPoint and see whether this might be a good time to consider owning its shares.
Source: WellPoint.
Debating earnings
There's little doubt that WellPoint's sales are heading higher. The company participated in the ACA insurance exchanges in 14 states, far more than competitors UnitedHealth Group and Cigna. As a result, WellPoint signed up almost 770,000 new members during Obamacare's first open enrollment, well above the 600,000 initially expected.
Rising Medicaid enrollment is also boosting the company's top line. The program's expansion lifted the number of members covered by WellPoint's Medicaid plans from 4.5 million a year ago to 4.8 million by the end of the second quarter.
That membership growth has WellPoint expecting to generate $73.5 billion in sales this year, up from $70 billion in 2013. But that revenue growth will only matter to investors if it translates into earnings.
Since insurers operate on notoriously thin margins and Affordable Care Act plan margins are expected to be in the low single-digit percentages, investors are right to wonder how much of that revenue growth will fall to the bottom line.
The good news for investors so far is that it appears WellPoint entered this year overly conservative. The company's original estimate for earnings per share in 2014 was $8, but WellPoint has increased that guidance twice and now expects to deliver $8.60.
Source: WellPoint.
That has encouraged Wall Street analysts to bump up their EPS estimate for this year to $8.71 from $8.56 just 90 days ago. Analysts have also increased their projection for 2015 to $9.29 from $9.20.
Even more intriguing to investors is that WellPoint management suggested during the second-quarter earnings conference call that there may be room to boost earnings even more. That's good news for investors, particularly given that competitors like UnitedHealth continue to expect earnings to fall this year from last year.
Debating valuation
Insurers usually don't trade at lofty price-to-sales or price-to-earnings levels, but WellPoint's shares are a bit rich relative to where they were just a couple years ago.
The company's price-to-sales ratio, which divides market cap by revenue, is just 0.49. That may be low when compared to other industries, but it still marks the highest level since the recession.
WLP PS Ratio (TTM) data by YCharts.
The situation is similar for WellPoint's price-to-earnings ratio, which at 15.6 is the highest in more than five years. WellPoint's forward P/E ratio is a bit more reasonable at 13.5, but that's hardly inexpensive considering that its forward P/E ratio was 8 in early 2013.
Fool-worthy final thoughts
WellPoint has a lot going for it. Demand for healthcare insurance is growing, and all those new members will provide the company with plenty of revenue it can leverage for profit-friendly share buybacks and dividends.
Despite those advantages, investors who have been on the sidelines may want to remain there -- at least for now. Shares are trading at lofty levels relative to where they've been in the past, and that may suggest it makes sense to be patient and wait the stock to dip.
