“Third leg is very controversial but we don’t shy from controversy on this show. It’s WellPoint, now what is WellPoint, WellPoint is the HMO that reported an absolute monster yesterday quarter. Earning $1.53 per share or $1.78 excluding one time items. 16 cents or 41 cents higher than the street was expecting. Wow.
Now everyone’s worried about health care reform. Especially with congress banging the health care drum all week. But I think the real story when it comes to WellPoint at least is its tremendous earnings power, the one that we saw demonstrated yesterday. Do you know that I don’t think that they could hide the earnings they were so powerful. Who wants to be an HMO and report big numbers right now. But they couldn’t help it. Even if we get a health care bill that knocks 25 cents off of WellPoint’s earning and I think tell probably be more like a dime. This shock is still cheap, trading about eight times earnings. Double-digit growth rate. I don’t have a stock just so that we are clear in my whole universe that has that growth rate with that low price to earnings multiple and stuff the stuff out of Pelosi this morning definitive move to the center to get everything passed. Emboldened us to think that maybe WellPoint’s earnings may not get dinged at all. I think that WellPoint goes to $53 by my calculation once the health care debate is over. Hey, I really don’t care how its resolved… ”–CNBC’s Mad Money 10/29/2009
With the recent weakness in the stock market, Jim Cramer is sticking to his investment thesis that this market will continue higher based on the three-legged stool of oil, tech, and financial sectors. However, each of these sectors have begun to look a little shaky based on less than impressive results from Exxon Mobil (XOM), Acer computers, and banks with credit concerns. In order to give more stability, he is recommending adding a defensive fourth leg to his stool metaphor.
At Ockham, we do not take issue with reducing risk in your portfolio at this juncture and some of Cramer’s recommendations are likely great long term buys. Those names include Procter and Gamble (PG), General Mills (GIS), Kellogg (K), and McDonald’s (MCD). However, he also includes Wellpoint (WLP)as a safe stock, which is certainly surprising to anyone who worries about the legislation being discussed in Washington.
From a valuation perspective, we are in complete agreement that WellPoint is certainly attractive as the fundamentals have continued to improve for this huge insurer. Furthermore, the fear of legislation has kept the stock down in very reasonable price levels. As our historical ratings chart suggests, we have seen this stock as Undervalued for some time. As Cramer points out, the double digit growth rate is exceptional with the low earnings multiple on WellPoint. However, we are cannot agree that this stock is defensive. There is still far too much up in the air in Washington that could adversely affect the HMOs.
Cramer still likes this stock if you were to take 25 cents off of WellPoint’s earnings, but will the rest of the market agree? Will the changes in Congress continue to eat away at the profitability of the HMO or could investors expect it to be a one time drop followed by stabilization? What will happen to the growth rate of WellPoint? Where does Cramer get his 25 cent or 10 cent expectations in the first place? There are simply too many questions that are unanswerable for us to subscribe to the theory that WellPoint is part of a defensive strategy. Simply because a stock is attractively valued does not mean that it is not speculative as well.