DaVita, which is Italian for "giving life" is precisely what DaVita, Inc. (NYSE:DVA), the company, does for its patients. This company has produced a superb record of consistent earnings growth that held through the recessions of 2001 and 2008 as if they never happened.
Demographics indicate a huge opportunity for this quality healthcare company that provides life-saving products and services to its patients. Consequently, we believe that the growth potential of this company is well defined, and significantly above average. Therefore, investors seeking above-average growth of principal should examine this company more carefully.
Growth stocks are defined as companies with high rates of change of earnings growth of 15% to 20%, or more. Growth stocks offer the potential for share prices to rise in lockstep with their profit growth in the long run. Therefore, the PEG ratio formula (price equals growth rate) tends to be the most appropriate formula used to value growth stocks. However, due to the exponential nature of compounding large numbers, PEG ratio forecasts are capped at 40%.
Because of the higher valuation typically awarded to fast growth, growth stocks offer the potential for greater capital appreciation. On the other hand, they also offer higher risk. First of all, they tend to command much higher than average PE ratios, and second, achieving very high levels of growth is very difficult to sustain. Consequently, forecasting future earnings growth is more important with high growth stocks than any other class of stock. Also, the average growth stock typically plows all of its profits back into the company to fund its future growth, instead of paying dividends.
DaVita, Inc: Large-cap growth at an attractive price
About the company, Directly from its website: "DaVita Inc., a FORTUNE 500® company, is a leading provider of kidney care in the United States, delivering dialysis services to patients with chronic kidney failure and end stage renal disease. DaVita strives to improve patients' quality of life by innovating clinical care, and by offering integrated treatment plans, personalized care teams and convenient health-management services. As of December 31, 2011, DaVita operated or provided administrative services at 1,809 dialysis facilities in the United States, serving approximately 142,000 patients. The company also operated 11 outpatient dialysis centers located in three countries outside the United States. DaVita supports numerous programs dedicated to creating positive, sustainable change in communities around the world. The company's leadership development initiatives and social responsibility efforts have been recognized by Fortune, Modern Healthcare, Newsweek and WorldBlu."
Earnings determine market price: The following earnings and price correlated F.A.S.T. Graphs™ clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.
DaVita, Inc: Historical earnings, price and normal P/E since 1998
Click to enlarge
Performance Table DaVita, Inc.
The two keys to long-term performance
Years of research and experience have taught us that there are two critically important keys to achieving above-average, long-term shareholder returns at reasonably controlled levels of risk. The first key is earnings growth, or what we like to call the rate of change of earnings growth. The faster a company can grow its business (i.e. earnings), the larger the income stream it can produce with which to reward shareholders. This is because of the power of compounding, which Albert Einstein was alleged to have called "the most powerful force on earth." Ultimately, both capital appreciation and dividend income will be a function of a company's ability to grow its profits.
The second key is valuation. When a company can be purchased at its intrinsic value based on earnings and cash flow generation, the shareholders' rate of return or long-term capital appreciation will inevitably correlate to and/or equal its earnings growth rate. Overvaluation will lower that rate of return and conversely, undervaluation will increase it. Consequently, paying strict attention to the valuation you pay to buy a stock is a critical component of both greater return and taking lower risk to achieve it. Because, ironically, when you overpay for even the best business, you simultaneously lower your return potential while increasing your risk of achieving the lower return.
The associated performance results with the earnings and price correlated graph, validates the above discussion regarding the two keys to long-term performance. Notice the impact that valuation (black line above or below orange earnings justified valuation line) had on the following performance results.
The following graph plots the historically normal P/E ratio (the dark blue line) correlated with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as normal as it has been since 1998.
A further indication of valuation can be seen by examining a company's current price to sales ratio relative to its historical price to sales ratio. The current price to sales ratio for DaVita, Inc. is 1.15 which is historically normal.
Looking to the future
Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:
1.The rate of change (growth rate) of the company's earnings
2.The price or valuation you pay to buy those earnings
Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.
Therefore, it logically follows that measuring performance without simultaneously measuring valuation is a job half done. DaVita, Inc. is clearly an industry leading superior business, which based on the consensus estimates from leading analysts, appears to be capable of growing earnings at an above-average rate for the foreseeable future. At its current price, which is attractively aligned with its True Worth™ valuation, DaVita, Inc. represents an opportunity for growth at a reasonable price. The important factor is that DaVita, Inc., with its strong balance sheet and potential for future earnings growth, has real assets and cash flow underpinning its stock price. This solid economic foundation offers shareholders the potential for both a strong margin of safety and an opportunity for outsized future returns.
The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.
The consensus of 8 leading analysts reporting to Capital IQ forecast DaVita, Inc.'s long-term earnings growth at 12%. DaVita, Inc. has long-term debt at 66% of capital. DaVita, Inc. is currently trading at a P/E of 16, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, DaVita, Inc.'s True Worth™ valuation would be $160.62 at the end of 2017, which would be a 11.2% annual rate of return from the current price.
Earnings Yield Estimates
Discounted future cash flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stake holders over time. Therefore, because Earnings Determine Market Price in the long run, we expect the future earnings of a company to justify the price we pay.
Since all investments potentially compete with all other investments, it is useful to compare investing in any perspective company to that of a comparable investment in low-risk Treasury bonds. Comparing an investment in DaVita, Inc. to an equal investment in 10-year Treasury bonds, illustrates that DaVita, Inc.'s expected earnings would be 6.3 times that of the 10-Year T-Bond Interest (see EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.
Summary and conclusions
This report presented essential "fundamentals at a glance" illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although, with just a quick glance you can know a lot about the company, it's imperative that readers conduct their own due diligence in order to validate whether the consensus estimates seem reasonable.
Although DaVita became extremely reasonably priced in September of 2011, and has subsequently recovered, we believe it still represents excellent long-term value. The only real negative we see with this consistent generator of above-average earnings growth is the company's level of debt. However, the company generates extremely strong cash flows that we believe mitigates the debt risk. Consequently, we believe this company represents an attractive long-term investment for investors seeking above-average growth. In the long run, earnings determine market price, and DaVita is a classic example of that, both historically, and we believe, futuristically.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.