Select Medical has had an impressive run over the past six months as its shares have beaten the S&P 500 by 15.8%. The stock now trades at $15.08, marking a 25.9% gain. This was partly thanks to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Select Medical, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.
Why Do We Think Select Medical Will Underperform?
We’re glad investors have benefited from the price increase, but we're cautious about Select Medical. Here are three reasons why SEM doesn't excite us and a stock we'd rather own.
1. Sales Volumes Stall, Demand Waning
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.
Over the last two years, Select Medical failed to grow its admissions, which came in at 8,859 in the latest quarter. 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 accelerate growth, factors that can hinder near-term profitability. 
2. EPS Trending Down
Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.
Sadly for Select Medical, its EPS declined by 11.7% 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. New Investments Fail to Bear Fruit as ROIC Declines
A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, Select Medical’s ROIC has unfortunately decreased. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
Final Judgment
Select Medical doesn’t pass our quality test. With its shares topping the market in recent months, the stock trades at 12.5× forward P/E (or $15.08 per share). While this valuation is reasonable, we don’t see a big opportunity at the moment. There are better stocks to buy right now. We’d suggest looking at the Amazon and PayPal of Latin America.
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