Select Medical’s 23.3% return over the past six months has outpaced the S&P 500 by 15.4%, and its stock price has climbed to $16.43 per share. This run-up might have investors contemplating their next move.
Is there a buying opportunity in Select Medical, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Is Select Medical Not Exciting?
We’re glad investors have benefited from the price increase, but we're swiping left on Select Medical for now. Here are three reasons why SEM doesn't excite us and a stock we'd rather own.
1. Demand Slips as Sales Volumes Slide
Revenue growth can be broken down into changes in price and volume (the number of units sold). While both are important, volume is the lifeblood of a successful Outpatient & Specialty Care company because there’s a ceiling to what customers will pay.
Select Medical’s admissions came in at 9,449 in the latest quarter, and they averaged 8.8% year-on-year declines over the last two years. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Select Medical might have to lower prices or invest in product improvements to grow, factors that can hinder near-term profitability. 
2. EPS Trending Down
We track the long-term change in earnings per share (EPS) because it highlights whether a company’s growth is profitable.
Sadly for Select Medical, its EPS declined by 14.1% annually over the last five years while its revenue was flat. This tells us the company struggled because its fixed cost base made it difficult to adjust to choppy demand.
3. High Debt Levels Increase Risk
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Select Medical’s $2.97 billion of debt exceeds the $25.68 million of cash on its balance sheet. Furthermore, its 6× net-debt-to-EBITDA ratio (based on its EBITDA of $483.3 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Select Medical could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope Select Medical can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
Select Medical isn’t a terrible business, but it doesn’t pass our quality test. With its shares beating the market recently, the stock trades at 12.7× forward P/E (or $16.43 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We're fairly confident there are better stocks to buy right now. Let us point you toward one of our top software and edge computing picks.
Stocks We Would Buy Instead of Select Medical
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