Is CVS Stock A Better Pick Over UNH Stock?

Health insurance companies have been in the limelight lately after the shooting of Brian Thompson, the CEO of the medical insurance arm of UNH. Furthermore, a news report suggesting that a bipartisan group of lawmakers may introduce legislation to force health insurance companies to divest their pharmacy business has raised concerns among investors. ^[1] Recently, Donald Trump proposed removing middleman in the pharmaceutical supply chain who contribute to inflating drug prices. This suggestion appears to target pharmacy benefit managers (PBMs) who negotiate drug prices between pharmaceutical manufacturers, insurance companies, and pharmacies. ((Trump ‘Middleman’ Remark Sinks CVS, UnitedHealth, Cigna Shares, John Tozzi, Bloomberg, Dec 16, 2024)) CVS Health stock (NYSE: CVS) saw a 17% fall in a week, while UnitedHealth Group stock (NYSE: UNH) is down 11%.

Between the two of them, given its attractive valuation, we believe CVS stock is currently a better pick. CVS stock trades at 7.3x trailing adjusted earnings, compared to 18.4x for UNH stock. UnitedHealth’s better revenue growth and profitability explains the difference between the two. However, we think this gap in valuation will narrow in favor of CVS over the coming years. In the sections below, we discuss why we think CVS is a better pick than UNH by comparing a slew of factors, such as historical revenue growth, returns, and valuation. Separately, if you want upside with a smoother ride than an individual stock, consider the High-Quality portfolio, which has outperformed the S&P, and clocked >91% returns since inception.

UNH’s revenue growth has fared slightly better than that of CVS

CVS has seen its revenue rise at an average annual rate of 10% from $269 billion in 2020 to $358 billion in 2023. On the other hand, UnitedHealth’s average revenue growth rate of 13% from $256 billion to $368 billion over this period has been comparatively better.

CVS Health’s revenue growth was driven by increased demand for COVID-19 testing and vaccine administration during the pandemic in 2020 and 2021. However, this trend has now reversed, given the lower demand for COVID-19 vaccination. On the positive side, the company’s healthcare benefits segment has seen a large 40% rise in revenue between 2020 and 2023, with improvement in both Medicare and Commercial plans. This was led by a rise in total medical membership, which currently stands at 27.1 million, compared to 23.4 million in 2020. This trend is expected to continue over the coming years, given the aging U.S. population. Lately, the company’s pharmacy and consumer wellness business has been doing well, driven by an increase in prescription volume and pharmacy drug mix.

UnitedHealth Group’s revenue growth over the recent years has primarily been driven by the increased demand for its OptumHealth business, which provides health care through local medical groups. For perspective, OptumHealth’s revenue grew 67% between 2020 and 2023, compared to a 44% rise in revenue for the overall company. The strong growth in the Optum Health business can be attributed to a rise in the number of patients served under the company’s value-based arrangements, including at-home services. The company’s other businesses, such as its pharmacy benefit management segment – OptumRx – has been faring well, and the overall rise in Medicare membership has aided its insurance business as well.

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Looking forward, we expect UnitedHealth to continue to see slightly better revenue growth, thanks to its OptumHealth business.

Also, UNH is more profitable

CVS’s operating margin fell from 5.2% in 2020 to 4.1% in 2023, while UnitedHealth’s operating margin contracted from 8.2% to 7.7% over this period. If we look at the last twelve-month period, UNH’s operating margin of 7.0% fares better than 2.9% for CVS.

Now, both companies have seen a fall in margins lately due to the rising medical costs. CVS saw its medical benefits ratio surge to 91.7% for the nine-month period ending September 2024, versus 80.9% in 2020. Similarly, this metric increased from 79.2% to 84.9% for UNH over the same period. With the aging population in the U.S. and a rise in overall health-related costs, the medical benefits ratio for both companies is expected to remain elevated in the near term.

UNH stock has a better financial position

Looking at financial risk, UNH seems to have an edge over CVS. Its 17% debt as a percentage of equity is much lower than 141% for CVS. Furthermore, its 12% cash as a percentage of assets is higher than 4% for the latter. This implies that UNH has a better debt position, and it has more cash cushion. A very high debt to equity figure for CVS can partly be attributed to a fall in market capitalization, given that the stock has lost nearly half of its value since early 2022.

UNH stock has fared much better than CVS in the last three years

CVS stock has seen a decline of 15% from levels of $60 in early January 2021 to around $50 now, vs. an increase of about 60% for UNH stock from $330 to $520. However, the changes in these stocks have been far from consistent. Returns for CVS stock were 55% in 2021, -8% in 2022, and -13% in 2023, while that for UNH were 45%, 7%, and 1%, respectively. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 — indicating that CVS and UNH underperformed the S&P in 2023.

In fact, consistently beating the S&P 500 — in good times and bad — has been difficult over recent years for individual stocks; for heavyweights in the Health Care sector including MRK, PFE, and JNJ, and even for the megacap stars GOOG, TSLA, and MSFT. In contrast, the Trefis High Quality Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride, as evident in HQ Portfolio performance metrics.

The verdict – CVS a winner?

We see that UNH has demonstrated better revenue growth, is more profitable, and has a better financial position. However, looking at valuation, we think CVS is the better choice of the two. At its current levels of around $47, CVS stock is trading at 7.3x trailing adjusted earnings of $6.36 per share, which is lower than the stock’s average P/E ratio of 9.8x over the last three years.

In comparison, at it current levels of $500, UNH stock is trading at 18.4x trailing adjusted earnings of $27.02 per share, versus the stock’s average P/E ratio of 23.1x over the last three years. Now, the PBM legislation could be a big blow to both companies, given the business accounts for a significant portion of revenues. Taking that into account and the rise in overall medical costs does make a fall in valuation multiple for both stocks seem justified. However, the valuation gap between them should narrow, as the profitability of CVS improves. CVS is undergoing restructuring aimed at improving efficiency and reducing costs. We estimate for CVS Health’s Valuation at $66 per share, reflecting nearly a 40% upside, and UnitedHealth Group’s Valuation to be $606 per share, reflecting over 20% upside from the current levels.

While CVS may outperform UNH in the next three years, it is helpful to see how CVS Health’s Peers fare on metrics that matter. You will find other valuable comparisons for companies across industries at Peer Comparisons.

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