The bad news for Amerigroup
Good news for Amerigroup shareholders, though: Yesterday's second-quarter report was a bit better than expected. Revenues came in at $565 million, up 29% sequentially, or 15.7% after factoring out the effects of an acquisition. The increase in health expenses choked margins, but net income still managed a respectable 8.2% increase. The health benefits ratio -- health expenses divided by premium revenue -- was 82.6%, up from 81.3% in the same period last year. Despite this substantial increase, investors were expecting even worse, and they promptly bid the shares up 8% on the good news. The stock remains down almost 14% from last Wednesday, but it's a start.
I own a small amount of Amerigroup shares. I bought in shortly after it was recommended in Motley Fool Stock Advisor and am very pleased with the gains. However, there are a few things that I'll be watching.
The first is stock options. Since the company doesn't expense them, their real effects are buried in the financial footnotes of the company's public filings. Had options been expensed in fiscal 2004, earnings would have been 10.8% less. In fiscal 2006, expensing these incentives will be required. Until then, be sure to adjust earnings down when valuing the shares.
Another unsettling factor is the company's ongoing tendency to acquire. Watch metrics such as return on equity (ROE) and return on invested capital (ROIC). If these start trending lower, management is probably overpaying for acquisitions. This foolish (small "f") strategy is right up there with issuing excess options in destroying shareholder value.
Noting the above factors and the company's short track record, investors are right to demand a margin of safety before buying in. That said, the company is growing fast even after factoring out acquisitions, and shares still change hands at only 21 times trailing earnings. The managed-care business isn't likely to go anywhere, nor is Medicaid. And with Amerigroup's focus on a specific program and clientele, I think it has a good chance of gaining market share and rewarding shareholders from now on.
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