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Are Managed-Care Stocks Overvalued?

Consolidation activity in the sector will have a positive impact operationally, but the stocks are overpriced, says Morningstar's Vishnu Lekraj.

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Vishnu Lekraj: Today, we will cover the managed-care sector, or MCO sector. These firms are the largest health insurers and control a significant portion of health-care spending in the U.S. Over the past year, there has been a huge increase in the stock prices for the major MCOs under our coverage, which consists of UnitedHealth (UNH), Aetna (AET), Anthem (ANTM), Cigna (CI), and Humana (HUM). These firms have outperformed expectations in the face of harsh headwinds; but more critically, the slew of consolidation activity among the major five has driven their stock prices by double digits over the past year.

Unfortunately, this has pushed many of the firms into overvalued territory in relation to our fair value estimates. The major merger activity has consolidated the major five MCOs into a major three, with Aetna buying Humana and Anthem buying Cigna. We believe these moves are a positive from an operational standpoint, but we also believe the market is overvaluing the expected synergies of these deals.

Accordingly, we would caution investors about making new equity positions within any of these players. While we are not pounding the table on any of the major five MCOs from a valuation standpoint, we would point investors to UnitedHealth if they are looking for exposure to the sector. United has historically been the group's outperformer, and we expect this trend to continue given its strong competitive positioning and economic moat.

Vishnu Lekraj does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.