UnitedHealth Has More Upside (NYSE:UNH)

UnitedHealth Group (UNH) is a healthcare giant, providing services to 147 million people. The company estimates that 2022 revenues will surpass $300 billion. UNH shares have risen more than 41% over the past 12 months, although the shares are 9% below the 52-week high closing price of $505.58 on December 29, 2021.

12-Month price history and basic statistics for UNH (Source: Seeking Alpha)

UNH’s forward P/E is 21.6, as compared to 17.8 a year ago. The company is doing well, but the question is whether the higher valuation still presents a compelling proposition. UNH’s quarterly EPS has beaten the consensus expected value in every quarter over the past 4 years. Most recently, for Q4 of 2021, the EPS was 4% above expectations. The growth outlook is solid, with expected EPS growth of 14.9% per year over the next 3 to 5 years. With year-on-year revenue growth of 12% for Q4 of 2021, this outlook seems reasonable. One wildcard is that some of UNH’s earnings surprise can be attributed to clients deferring a range of care services during COVID.

Trailing and estimated future quarterly EPS for UNH. Green values are amounts by which the EPS exceeded the consensus estimate for the quarter (Source: ETrade)

I last wrote about UNH on February 18, 2021, almost exactly one year ago. At that time, the shares had dipped about 7% since the start of the year. The fundamentals looked reasonable. The Wall Street consensus outlook for the shares was robustly bullish, with a consensus 12-month price target that was about 22% above the share price at that time and a forward dividend yield of 1.54%. The trailing 5- and 10-year annualized total returns were both above 23% per year, so this outlook was not implausible.

Performance of UNH vs. the S&P 500 since my last article on UNH on February 18, 2021 (Source: Seeking Alpha)

In addition to looking at the fundamentals and the Wall Street consensus, I rely on the options market to provide another form of consensus outlook. The price of an option on a stock reflects the market’s consensus estimate of the probability that the share price will rise above (call option) or fall below (put option) a specific level (the options strike price) between now and when the option expires. By analyzing the prices of call and put options at a range of strike prices, it is possible to calculate a probabilistic price forecast that closely reconciles the options prices. This is called the market-implied outlook and is, in effect, the consensus view among buyers and sellers of options. For readers with a statistical bent, I recommend this monograph from the CFA Institute that goes into depth on this approach. As of February of 2021, the market-implied outlook for UNH to early 2022 was neutral, with moderate volatility.

Considering the fundamentals, the bullish Wall Street consensus with 22% expected price appreciation, and the neutral market-implied outlook with reasonable volatility, I assigned UNH a bullish rating. UNH has risen 41.1% since this post, as compared with an 8.3% gain for the S&P 500 (not including dividends in either case).

I have calculated the market-implied outlooks for UNH to mid-2022 and to early 2023 and compared these with the Wall Street consensus outlook in updating my opinion.

Wall Street Consensus Outlook for UNH

ETrade calculates the Wall Street consensus outlook by combining the views of 20 ranked analysts who have published ratings and price targets for UNH within the past 90 days. The consensus rating is bullish and the consensus 12-month price target is 14.6% above the current share price. Of the 20 analysts, 17 assign a buy rating and 3 assign a hold on UNH. A year ago, ETrade’s calculation of the Wall Street consensus was also bullish and the consensus 12-month price target was 22.9% above the share price at that time.

Wall Street analyst consensus rating and 12-month price target for UNH (Source: ETrade)

Seeking Alpha’s version of the Wall Street consensus is calculated from the views of 26 analysts who have updated their opinions within the past 90 days. Very similar to the ETrade results, the consensus rating is bullish and the consensus 12-month price target is 14.3% above the current share price. Only 1 of the 26 analysts assigned a sell rating, with 3 who give UNH a hold rating and 22 who put a buy rating on the stock.

Wall Street analyst consensus rating and 12-month price target for UNH (Source: Seeking Alpha)

The Wall Street consensus outlook is bullish, as it was a year ago and has been through the past 12 months. The consensus 12-month price target provides room for significant price appreciation, albeit with less anticipated upside than a year ago.

Market-Implied Outlooks for UNH

I have calculated the market-implied outlook for the 3.7-month period from now until June 17, 2022 and for the 10.8-month period from now until January 20, 2023, using options that expire on these two dates. There is a high level of open interest and trading in options on UNH, adding confidence in the representativeness of the outlooks. I selected these two expiration dates to provide a view to the middle of 2022 and for the full year.

The standard presentation of the market-implied outlook is in the form of a probability distribution of price return, with probability on the vertical axis and return on the horizontal.

Market-implied price return probabilities for UNH for the 3.7-month period from now until June 17, 2022 (Source: Author’s calculations using options quotes from ETrade)

The market-implied outlook from now until June 17, 2022 is generally symmetric with similar probabilities for positive and negative returns of the same size, although the distribution is tilted to favor positive returns. The peak probability corresponds to a price return of only +1%, but the tilt in probabilities is very evident from the substantially higher probability of having a +10% return as compared to -10% on the chart above. The annualized volatility calculated from this distribution is 31%.

To make it easier to directly compare the probabilities of positive and negative returns of the same magnitude, I rotate the negative return side of the distribution about the vertical axis (see chart below).

Market-implied price return probabilities for UNH for the 3.7-month period from now until June 17, 2022. The negative return side of the distribution has been rotated about the vertical axis (Source: Author’s calculations using options quotes from ETrade)

This view makes it very clear that the probabilities of positive returns are consistently higher than for negative returns of the same size over a wide range of the most probable outcomes (the solid blue line is notably higher than the dashed red line over the left half the chart above). This is a bullish outlook. Also notable, the probabilities of large-magnitude positive and negative returns are very close to each other. This market-implied outlook is more bullish than the equivalent outlook using June options from a year ago.

Theory suggests that the market-implied outlook will be negatively biased because investors, in aggregate, tend to be risk averse and thus tend to pay more than fair value for downside protection (put options). While there is no way to measure this effect, the potential for this bias makes the market-implied outlook for UNH to mid-2022 look even more bullish.

The market-implied outlook for the 10.8-month period from now until January 20, 2023 is consistent with the view to mid-2022, albeit less bullish (the solid blue line is consistently above the dashed red line, although the spread is smaller than for the June outlook). The annualized volatility calculated from this distribution is 30.3%. The outlook to January of 2023 is more bullish than the outlook to January of 2022 from one year ago.

Market-implied price return probabilities for UNH for the 10.8-month period from now until January 20, 2023. The negative return side of the distribution has been rotated about the vertical axis (Source: Author’s calculations using options quotes from ETrade)

The market-implied outlooks to the middle of 2022 and into early 2023 tell a consistent story. The outlook to the middle of June is bullish and the outlook to January of 2023 is also bullish. The annualized volatility is the same for these two outlooks, at 30%-31%, the same expected volatility from the analysis one year ago. The market-implied outlooks are more bullish today than they were in February of 2022.

Summary

UNH had a strong 2021, with substantial earnings growth that continues a multi-year trend. With the shares costing 41% more than a year ago, and in light of rising rates which imply a higher discount factor on future earnings, an updated analysis is due. The Wall Street analyst consensus continues to be solidly bullish, with a consensus 12-month price target that implies 14.4% in price appreciation for a 12-month expected total return of 15.6%. As a rule of thumb for a buy rating, I want to see an expected 12-month total return that is at least ½ the expected volatility (30%-31% from the market-implied outlook). UNH just meets this criterion. The market-implied outlooks to the middle of 2022 and to early 2023 are both bullish. I am maintaining my bullish rating on UNH.