Healthcare is often thought of as a defensive sector, but there are companies within this category that investors might consider to be growth stocks. One such name is Humana Inc. (HUM), a stock held by institutional investors such as Maverick Capital. 

Human’s returns over the past five years are double that of the S&P 500 index. Over the last year, shares of Humana are higher by 23% while the market index has increased by 15%. At Sure Dividend, we are more concerned with where stocks are going than where they came from. This article will look at Humana’s business model and its potential returns to determine if now is the best time to buy Humana.

Business Overview and Recent Earnings Results

Human is one of the largest publicly traded healthcare benefit companies in the U.S. The company has nearly 17 million medical members and an additional 5.4 million members in specialty products. The company offers a wide range of health and benefit plans for customers in the government, the private sector, and individuals. Humana has a current market capitalization of $54 billion and generated almost $65 billion in revenue in 2019.

The company reported third quarter earnings results on November 3. Adjusted earnings-per-share decreased 39% to $3.08, but was $0.28 ahead of analysts’ estimates. Revenue improved 23.6% to $20.1 billion, $1.5 billion better than expected.

The decrease in adjusted earnings-per-share stems from higher utilization rates compared to the previous year. Much of this impact on results was from COVID-19 testing and the costs related to treatment for the virus. COVID-19 related costs will likely be in the neighborhood of $1 billion for the year.

Non-COVID-19 medical utilization was at approximately 95% of pre-pandemic levels. Human expects full-year membership to grow by approximately 375K members, ahead of its previous range of 330K to 360K.

Human has guided towards adjusted earnings-per-share of $18.50 to $18.75 for the year. Even with an expected loss for the fourth quarter, the midpoint for Human’s guidance would result in a 4.3% gain from the previous year.

Growth Prospects, Dividend History, and Potential Returns

One of Humana’s chief prospects for growth is that healthcare is a necessity regardless of the economic environment. Recessions usually include job losses, but more than 80% of premiums and services last year came from government contracts. These positions are often more secure than private-sector jobs. Another point in Humana’s favor is that the COVID-19 pandemic, though a significant challenge, is an uncommon occurrence that the company, along with the rest of the market, is dealing with.

Human has compounded earnings-per-share at a rate of 10.7% from 2010 through 2019. Much of this growth has occurred over the past few years. We believe an 8% annual earnings growth rate over the next five years is more likely to occur.

Shares of Humana have traded with an average price-to-earnings ratio of 15.1 over the last 10 years. This past decade was a tale of two different valuations. The stock had a single-digit earnings multiple for the first part of the decade that it expanded into the 20s near the end of the period. We believe a price-to-earnings ratio of 17 takes into account the long-term average while demonstrating that Human deserves a slight premium to the historical average due to recent business results.

Human closed Tuesday’s trading session at $408. Using expected earnings-per-share for the year, the stock has a forward price-to-earnings ratio of 21.9. If the stock were to revert to our target price-to-earnings ratio by 2025, then valuation would reduce results by 4.9% annually over this period of time.

Human has increased its dividend for 10 consecutive years, including a 13.6% raise for the April 24, 2020 payment. This is slightly below the five-year CAGR of 16.6%. The annualized dividend of $2.50 results in a dividend yield of 0.6% at current prices. Human enjoys a very low payout ratio at just 13.4% of expected adjusted earnings-per-share for 2020.

Total returns would consist of the following:

• 8% earnings growth
• 4.9% multiple reversion
• 0.6% dividend

In total, Human is expected to deliver annual returns of 3.7% through 2025.

Final Thoughts

Humana was greatly impacted by the COVID-19 pandemic in the third quarter, with much of the pain being felt on the bottom-line. Revenue was higher year-over-year, which shows that the company’s products remain in high demand among consumers.

However, expected returns over the next five years are not attractive enough to warrant purchasing at the moment in our view. An 8% earnings growth and a small dividend yield will be offset by a mid-single-digit headwind from multiple reversion. Therefore, Human earns a hold recommendation from Sure Dividend at this time.

Author disclosure: the author does not have a position in any stock mentioned in this article.