Over the past six months, Encompass Health’s shares (currently trading at $112.50) have posted a disappointing 6.5% loss, well below the S&P 500’s 14.1% gain. This may have investors wondering how to approach the situation.
Is now the time to buy Encompass Health, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free for active Edge members.
Why Is Encompass Health Not Exciting?
Despite the more favorable entry price, we're sitting this one out for now. Here are two reasons there are better opportunities than EHC and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance is one signal of its overall quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Over the last five years, Encompass Health grew its sales at a mediocre 4.7% compounded annual growth rate. This was below our standard for the healthcare sector.
2. Free Cash Flow Margin Dropping
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, Encompass Health’s margin dropped by 1.3 percentage points over the last five years. Continued declines could signal it is in the middle of an investment cycle. Encompass Health’s free cash flow margin for the trailing 12 months was 13.3%.
Final Judgment
Encompass Health isn’t a terrible business, but it doesn’t pass our bar. After the recent drawdown, the stock trades at 20× forward P/E (or $112.50 per share). This valuation is reasonable, but the company’s shakier fundamentals present too much downside risk. We're pretty confident there are superior stocks to buy right now. We’d recommend looking at the most dominant software business in the world.
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