Value Investor Daily #76

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The Dow Jones dropped for the 9th day in a row, its longest losing streak in 46 years— since 1978. The drop is primarily due to the recent precipitous drop in United Health’s (UNH) stock.

A peculiarity of the Dow Jones Industrial Average, created in 1896 by Charles Dow, is that, unlike most other modern index funds like the S&P 500, the Dow is not a market cap-weighted average but a price-weighted average.

That means the stocks with the highest stock prices impact the index the most. This is why you’ll sometimes see high-priced stocks split their share price before they enter the Dow. It’s also why Berkshire Hathaway (BRK.A) could never be added; it would dominate the entire index.

It also means that the recent 22% drop in United’s stock in the wake of the tragic assassination of their CEO, the public’s outcry against claims denials, and Trump’s recent comments stating "we are going to knock out the middleman,” referring to pharmacy benefit managers—has had an outsized impact on the Dow.

Before dropping from $630 down to $485, United had the highest share price in the Dow. Now, Goldman Sachs holds the top spot at $574 per share.

United’s market cap is $446 billion, compared to Apple’s (AAPL) $3.83 trillion market cap and $253 share price.

Even though United’s market cap is 89% less, its impact on the Dow Jones was nearly 2.5 times that of Apple's until two weeks ago. Now it’s only. 1.9x.

This is why you must understand what you own, whether individual stocks or a fund.

The Dow Jones is packed with relatively stable, dividend-paying, value-style names, but would you rationally allocate 2.5 times more to United Health than to Apple in your own portfolio? Both are huge companies, but which is more relevant to the global economy?

It’s a fine index to follow, but given its pricing method, it doesn’t make much sense to own it outright. Occasionally, you get these sorts of share price effects, like we’ve seen this week with United Health.

What about United Health? Will the company survive? Probably, yes. While Trump wants to push major healthcare reforms, he won’t nationalize healthcare, so private insurance is here to stay.

The company is almost 50 years old, has over 400,000 employees, and insures over 140 million people worldwide.

Their PBM business, OptumRX, contributes a significant percentage of United’s total revenues: around 33%. The segment coordinates drug pricing and schedules between customers, pharmacies, drug manufacturers, and employer plans. Its margins could be squeezed if Trump persuades Congress to pass new transparency rules, but it’s unlikely to be eliminated entirely.

The stock trades for 18.45x TTM GAAP earnings. Earnings are expected to nearly triple in the next decade from $27 to $74 per share by 2034. If earnings do grow that much and the shares trade at an earnings yield equivalent to the 10-year treasury (4.4% right now), the stock would reach around $1680 (a 13.2% annualized CAGR), continuing its high impact on the Dow Jones. Including the 1.6% dividend would bring it to 14.8%.

Perhaps it's a bit too soon, morbid, or macabre to consider buying shares after a slain executive. Still, as value investors, our job is always to stay clear-eyed and rational, even amidst tragedy, chaos, and constant market and economic noise. In ten to twenty years from now, there’s a very high chance United Health will still have a large and profitable business with hundreds of millions of customers.

As always, do your own research before making any investment.

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