AET Aetna Inc. (delisted)

Industry Rank Analysis 6-7-11

Health Care policy has dominated the political agenda like no other for the last three years. First was the debate over “Obamacare,” then the attempts by the GOP to do way with it, either through a direct repeal, or by stealth though defunding it and blocking of key regulations. Then came the Ryan Plan to turn Medicare into a voucher program.

While “Obamacare” was not as onerous on the HMO and hospital industries as many feared during the debate on it, as many of the potentially more problematic features for these industries, such as the public option did not make it into the law, on balance it is a negative for both of the industries, especially the HMO industry. It puts an end to the wildly lucrative (for the HMOs) “Medicare Advantage” program.

“Ryancare,” if it were to pass (highly unlikely), would be a HUGE plus for the HMO industry. It would probably be a negative for the hospital industry, as many seniors would not be able to afford insurance, leading to higher rates of charity care, or simply some seniors going without care, thus shrinking their market. However, even if it were to be signed into law today by President Obama, it would not have a big impact for more than a decade.

With all that background in mind, it is worth noting that both of these industries are near the top of the heap when it comes to the Zacks Rank. The rate of medical inflation has come way down in recent years (as measured by the Health Care Commodities, and Health Care Services components of the CPI), but the health insurers continue to raise premiums at double-digit rates. The limits on their ability to raise rates don’t really kick in until 2014.

Zacks Industry Classifications

The Zacks industry classifications are very fine, with 256 different industries tracked. It is not particularly noteworthy if a single small industry shows up doing well -- a single firm with good news can propel a one or two firm industry to the top (or bottom) of the charts.

It is interesting when you see a cluster of similar industries at the top of the list. The same holds true for the bottom of the list. The definition of size that matters here is not the total sales or market capitalization but the number of companies in the “industry.”

The Top Hospital & HMO Companies

Both the Hospital and HMO industries are somewhat larger than average in terms of number of firms, but neither is huge, at 9 and 18 firms respectively. The HMO industry is more concentrated than the 18 firms would imply. Four firms: United Health Care (UNH), Humana (HUM), Aetna (AET) and Wellpoint (WLP) control the bulk of the market, and often just one or two firms will have the vast bulk of the premiums in a given state.

They are in a tie for 17th place among the 256 Zacks “industries.” Both have average scores of 2.33, but are headed in slightly different directions. The HMO industry slipped two spots as its average rank rose from last week’s 2.28. The hospital industry improved 10 spots as its average rank fell from 2.44.

The first table shows the hospital and HMO stocks that hold the vaunted Zacks #1 Rank (Strong Buy). The second table shows the Zacks #2 Ranked (Buy) firms. If the Zacks Ranks were random, one would expect that only 5% of the firms in an industry would be “#1s” and 15% would be “#2s”.

That is not the case with the hospital and HMO firms. There are a total of 27 firms in the two industries. Four of them (14.8%) have number five ranks, and 11 (40.7%) have number four ranks. The four dominant HMO stocks are all large caps, but most of the rest and mid-caps, with a few small caps also available.

Even though these firms have generally been extremely strong performers so far this year, the valuations are still very reasonable, especially if you are willing to look forward to 2012 earnings. Keep in mind that the estimates are rising (a key to having a strong Zacks Rank). Since an estimate in motion tends to stay in motion, it is likely that these firms will actually earn more than the current consensus estimates are forecasting. That, in turn, means that the “real P/E” is even lower than shown in the tables below.

At this point, the most likely political case is gridlock over health care policy. That should allow some of the uncertainty over these stocks to dissipate. They just might prove the key to keeping your portfolio healthy.

Number 1 Ranked Firms

Company	Ticker	Market Cap ($ mil)	P/E Using Curr FY Est	P/E Using Next FY Est	% Change Curr FY Est - 4 wk	% Change Next FY Est - 4 wk	Current Price
Unitedhealth Gp	UNH	$52,926	11.75	10.57	0.45%	2.24%	$48.85
Humana Inc New	HUM	$13,138	11.11	10.68	0.42%	2.04%	$78.02
Univl Hlth Svcs	UHS	$5,181	13.39	11.88	-0.03%	0.06%	$53.04
Amerigroup Corp	AGP	$3,391	15.48	15.23	1.65%	0.91%	$68.36

Number _____ Ranked Firms

Company	Ticker	Market Cap ($ mil)	P/E Using Curr FY Est	P/E Using Next FY Est	% Change Curr FY Est - 4 wk	% Change Next FY Est - 4 wk	Current Price
Wellpoint Inc	WLP	$28,154	10.98	10.04	0.79%	0.52%	$76.68
Hca Holdings	HCA	$17,604	12.28	11.28	3.71%	2.19%	$34.14
Aetna Inc-New	AET	$16,394	9.97	9.48	1.43%	3.52%	$43.20
Tenet Health	THC	$3,060	14.7	12.8	5.01%	2.13%	$6.25
Health Mgt Assc	HMA	$2,755	14.25	12.53	0.23%	0.21%	$10.88
Lifepoint Hosp	LPNT	$2,103	12.91	11.79	0.10%	0.00%	$40.07
Centene Corp	CNC	$1,719	16.21	14.44	0.06%	0.14%	$34.40
Magellan Hlth	MGLN	$1,670	14.43	12.67	1.23%	0.61%	$52.06
Select Medical	SEM	$1,392	11.91	10.56	7.57%	5.63%	$9.02
Triple-S Mgmt-B	GTS	$626	9.87	9.06	0.30%	0.00%	$21.69
Metro Hlth Net	MDF	$187	6.71	5.54	0.00%	0.00%	$4.54

In evaluating the Zacks Industry Ranks, you want to see two things: a good overall score (low, meaning more Zacks #1 and #2 Ranked stocks than #4 or #5 Ranked stocks) and some improvement the relative position from the prior week. It is also helpful to understand exactly what the Zacks Industry Rank is.

The Zacks Industry Rank is the un-weighted average of the individual Zacks ranks of the firms in that industry. It does not matter if the stock is the 800 lb gorilla that dominates the industry or some very small niche player in the industry -- they have the same influence on the industry rank.

Also, that means that the bigger the industry in terms of number of firms, the less influence any given company has on the industry rank. It also implies that small industries, with just two or three firms, should be the ones found at either the top or the bottom of the list. After all, if there are only two firms in the industry, it is relatively easy to get a Zacks rank of 2.00 (i.e. one with a Zacks Rank of #1 and the other with a #3). Right now, that industry rank would be tied for 6th place among the 255 industries tracked.

The same obviously goes for the bottom of the list as well. If there are 50 firms in the industry, and it ends up at one of the extremes, that means there has to be something pretty significant going on. Thus, I do not always focus on the very highest rated industries, but on the highest rated ones in which there are a large number of firms.

Click here for the Zacks Industry Rank List: http://www.zacks.com/zrank/zrank_inds.php
 
AETNA INC-NEW (AET): Free Stock Analysis Report
 
HUMANA INC NEW (HUM): Free Stock Analysis Report
 
UNITEDHEALTH GP (UNH): Free Stock Analysis Report
 
WELLPOINT INC (WLP): Free Stock Analysis Report
 
Zacks Investment Research