The biggest health insurer in the land also claims one of the best-performing stocks in the S&P 500 Index. UnitedHealth Group's (UNH -0.00%) share price has been routinely setting new all-time highs this summer. The stock is now up 21% so far in 2018.
But should investors still view UnitedHealth Group as a great stock to buy, or is the wiser approach to either sell or hold after the big gains? Here's what you need to know about the prospects for the top health insurance stock.
Lots of positives
All you have to do is look at UnitedHealth Group's second-quarter results to understand why the stock has been performing so well. The company posted solid revenue growth and even more impressive earnings growth. Things have gone so well for UnitedHealth that it increased its full-year 2018 earnings guidance for the second time this year.
There are several major positive factors working in UnitedHealth's favor right now. One is the company's revenue mix. Enrollment in UnitedHealth's Medicare Advantage plans continues to grow faster than other areas, with solid enrollment growth in Medicaid as well. This is good for the company because, as CFO John Rex noted in UnitedHealth's Q2 conference call, Medicare and Medicaid have lower operating cost ratios.
Even better, it's highly likely that UnitedHealth's Medicare business will keep growing. Roughly 10,000 baby boomers reach age 65 every day and qualify for Medicare. As the largest health insurer in the U.S. offering plans across the country, UnitedHealth should be very competitive in winning new members to its Medicare Advantage plans.
Another big plus for UnitedHealth is its Optum business unit. While the company's health insurance business generates the most revenue, Optum is much more profitable. UnitedHealth is enjoying especially strong growth with its OptumHealth and OptumInsight businesses. OptumHealth provides care delivery, care management, wellness and consumer engagement, and health financial services. OptumInsight provides healthcare information technology services.
As you might expect, UnitedHealth generates strong free cash flow. The company continues to use its cash flow in three key ways that benefit investors. First, it has bought back a lot of its stock, spending over $3.1 billion in the first half of 2018 alone on share repurchases. Second, UnitedHealth has completed several acquisitions, including the $2.2 billion buyout of physician staffing company Sound Inpatient Physician Holdings LLC.
The third way that UnitedHealth uses its cash flow is to pay dividends. Although the current yield of 1.36% isn't all that impressive, the company boosted its dividend payout by 20% in June. With a really low payout ratio of 26%, UnitedHealth Group appears to be in great shape to continue hiking its dividend in the future.
But some threats, too
Is there a potential fly in the ointment for UnitedHealth Group? Maybe. Actually, there could be a couple of them.
The political climate for pharmacy benefits managers (PBMs) isn't favorable right now. UnitedHealth's OptumRx ranks as the third largest in the U.S. President Trump has promised to implement drug pricing reforms focused on "eliminating the middleman," a reference to PBMs.
It remains to be seen how significant the impact of drug pricing reform will be on UnitedHealth. However, with OptumRx generating 30% of the company's total revenue, even a moderately negative effect could hurt the company's bottom line.
But there's a much greater worry that could be catastrophic for UnitedHealth. Sen. Bernie Sanders, the Vermont Independent, is promoting his Medicare for All plan that would move the U.S. to a single-payer healthcare system. Would this plan mean that health insurers such as UnitedHealth disappear? Not necessarily.
Remember that UnitedHealth has a thriving business currently with its Medicare Advantage plans. Several countries with single-payer healthcare systems still have private insurers. However, it's not surprising that the health insurance lobbying organization, America's Health Insurance Plans (AHIP), opposes a single-payer healthcare system. Sen. Sanders' Medicare for All proposal could be the single greatest threat that UnitedHealth Group faces.
Buy, sell, or hold?
In my view, the decision on what to do about UnitedHealth Group stock comes down to probabilities. There's a 100% chance that many more Americans will soon be eligible for Medicare. Considering UnitedHealth's prominence in the market, there's a high likelihood that the company will attract many of these individuals to its Medicare Advantage plans.
I would also assign a high probability to UnitedHealth continuing to generate strong cash flow and using that cash flow in ways that reward investors. You can pretty much count on more stock buybacks, more acquisitions, and higher dividend payouts.
What about the risks? Despite the president's statements about eliminating the middlemen, I think the likelihood that the role of PBMs will be eliminated is quite low. There's a good chance that regulatory changes could hurt UnitedHealth, but not enough in my view to outweigh the other positives for the company.
As for Sanders' Medicare for All proposal, I don't see it happening. Although public support has increased for such a plan, we'd have to see the presidency and both the Senate and the House of Representatives swing from Republican control to Democratic control. While that scenario could unfold, it won't happen until 2021 at the earliest. My hunch is that we would see a massive campaign by health insurers, hospitals, and pharmaceutical companies to stop a shift to single-payer healthcare, probably even bigger than the one that thwarted Hillary Clinton's healthcare plan in the 1990s.
With all of this in mind, I think that UnitedHealth remains a stock to buy for now. At worst, it's a stock to hold if you already own it. Of course, if the political scene changes dramatically over the next few years, the risks to UnitedHealth Group could increase.