Dominant Player Doesn't Equal Profits
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investors sometimes forget that companies and stock values are not the same. Sometimes you have opportunity where the market undervalues what is going on. Other times the market has too high of expectations and the stock corrects, even when the company is doing fine. The latter situation is what is likely to happen to WebMD Health Corp (NASDAQ: WBMD). According to the company they are the “leading provider of health information services...”. I normally like to own stocks in companies that lead their field, but this situation appears different.
WebMD currently has the following numbers:
Current Price: $27.50
P/E based on '12 earnings: 59.78
Growth expected: 16.67%
Do you see that last number? With a PEG on forward earnings of 3.59 the market is placing a serious premium on WebMD's growth going forward. There are likely two factors that play into this. First, the company's previous growth rate is over 36%. With previous growth at such a high rate there is always a temptation to believe that growth will continue indefinitely. If forward earnings projections were for 36% then a P/E north of 59 would be high, but not ridiculous. The problem is forward projections are only for growth of over 16%. The second factor that likely plays into WebMD's PEG ratio is the drastic cut in their expected earnings for full year 2012. Just 30 days ago the full year 2012 estimate was about $0.94. Today the full year average estimate stands at just $0.46. Analysts are telling investors to expect much less from WebMD's growth. The one caveat to WebMD's much lower expected earnings is, the company has been trouncing analyst estimates. In the last 4 quarters WebMD has beaten analyst estimates all 4 quarters by an average of 52%! If we build in this type of earnings beat going forward we come up with estimates for 2012 at $0.70. If WebMD were to meet this 52% average beat for full year 2012, the PEG is still 2.35. To be more realistic the PEG should be about 1.5 or less. If the stock sold for a PEG of 1.5, and did earn $0.70, the stock would only be worth about $18. Since $18 is 34.8% down from current prices that's just not a trade I would consider.
Where the company's cash flow and balance sheet are concerned, WebMD doesn't concern me near as much as their current valuation. They are cash flow positive and have repurchased shares in 2 of the last 4 quarters. Their balance sheet shows a net cash position of about $300 million as well.
The problem with this company lies solely with valuation. WebMD in their dominance of the online health industry reminds me of Ancestry.com (NASDAQ: ACOM). Ancestry.com commands the leading spot in the genealogy industry as WebMD dominates the online health industry. Ancestry.com has good cash flow and a good balance sheet just like WebMD. That is where the similarities end though. Ancestry.com is growing and beating analyst estimates, but sells for about 1.25 times its growth rate. With WebMD selling for more than 3.5 times its growth rate, investors are saying that WebMD is 180% more valuable than Ancestry.com? I don't see how that's possible.
You have to come up with some pretty strong assumptions that analysts are just not seeing to value WebMD at its current price. When everyone else's best case scenario is your assumption you are treading on thin ice. I'm giving WBMD a red thumbs-down on CAPSCall today. I like WebMD the company, but my diagnosis for WebMD shareholders is a reduction in their holdings.
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