Investment Outlook: Quality Investing: Recent Changes to Our Portfolios Driven by Beese Fulmer Buy and Sell Disciplines.
In our previous discussion, we outlined our quality investing process which emphasizes companies with predictable growth, strong profitability, and judicious capital allocation. This article expands on the process by shedding light on our sell discipline, a critical component for minimizing risk and maximizing returns within our portfolio. This process constantly monitors our holdings against the three quality pillars: predictability, profitability, and judicious capital allocation.
A recent example of our sell discipline in action is CVS Health (CVS). Their stock price has been under significant pressure throughout 2023 due to several factors impacting their short-term profitability. Financial analysts point out that CVS's recent aggressive acquisition strategy, while aiming for future growth, is currently a drag on their finances. Integrating new businesses like Signify Health (acquired in 2022 for $8 billion) and Oak Street Health (finalized in early 2023 for $10.6 billion) involves substantial upfront costs and presents challenges in aligning operations and company cultures. These hurdles and uncertainties surrounding future profitability are significantly contributing to their short-term financial strain.
Further compounding these issues, CVS was forced to revise their full-year earnings forecast downward in both August and November of 2023. This suggests the company might be facing difficulties meeting profit expectations, leading to a negative investor reaction. Additionally, the loss of a major client like Blue Shield of California in August for their pharmacy benefits management (PBM) services raises concerns about a potential trend of other insurers following suit, which could significantly impact CVS's revenue stream. The overall healthcare landscape is also presenting challenges for CVS. A decline in demand for COVID vaccines and changes in Medicaid contracts have negatively impacted their core pharmacy business. While CVS has made efforts to adapt through acquisitions in the healthcare service space, these ventures have not yet translated into the level of profitability needed to meet our prior expectations.
Our sell discipline highlights the importance of continuous monitoring. In the case of CVS, their recent acquisitions, lowered earnings guidance, and struggles to adapt to the changing healthcare landscape all weaken the predictability, profitability, and capital allocation aspects of our quality investing criteria. This suggests that CVS may not be the best investment opportunity at this time.
Conversely, UnitedHealth Group (UNH) presents a compelling opportunity that aligns with our quality investing criteria. UNH boasts a strong track record of consistent earnings growth, with a target of 13-16% annually. This predictability is further bolstered by their dominant market share in the private health insurance market, allowing them to negotiate favorable rates with hospitals and drug companies, solidifying their profitability. Additionally, UNH consistently generates robust free cash flow, providing them with the flexibility to invest in growth opportunities and shareholder-friendly initiatives like dividend increases and stock buybacks. This commitment to shareholder value aligns with our focus on judicious capital allocation.
We think UNH is currently undervalued and believe the stock could be trading closer to $600 based on a P/E multiple of ~21.5x our FY24 adjusted EPS estimates in the near future. This valuation reflects the premium we assign to UNH due to its diversified platform with the high-growth Optum segment. Optum leverages its integration with UnitedHealthcare to drive value-based care models, offering significant long-term growth potential. We believe a higher P/E multiple is justified considering UNH's proven ability to execute operationally, consistently exceeding earnings expectations. We also expect that the recent news surrounding Medicare Advantage will provide us with additional opportunities to add to our position in UNH as near-term pricing pressures provide us with even better entry levels in the stock.
In conclusion, UNH's impressive scale, diversified service offerings, consistent growth, and commitment to shareholder value make it a strong fit for our quality investing criteria. The company's strong fundamentals and prospects justify a future higher valuation. By applying our sell discipline to CVS and identifying an opportunity in UNH, we aim to manage risk and maximize returns for our clients within our quality investing framework.
Past performance is not indicative of future results. The material above has been provided for informational purposes only and is not intended as legal or investment advice or a recommendation of any particular security or strategy. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Information obtained from third-party sources is believed to be reliable though its accuracy is not guaranteed, Beese Fulmer Private Wealth Management ("Beese Fulmer") makes no representation or warranty as to the accuracy or completeness of the information, which should not be used as the basis of any investment decision. Information contained on third-party websites that Beese Fulmer may link to is not reviewed in their entirety for accuracy and Beese Fulmer assumes no liability for the information contained on these websites. Opinions expressed in this commentary reflect subjective judgments of the author based on conditions at the time of writing and are subject to change without notice. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Beese Fulmer. For more information about Beese Fulmer, including our Form ADV brochures, please visit https://adviserinfo.sec.gov and search for our firm name.
