In a sliding market, Encompass Health has defied the odds, trading up to $120.20 per share. Its 15.8% gain since November 2024 has outpaced the S&P 500’s 3.6% drop. This was partly due to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is there a buying opportunity in Encompass Health, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Is Encompass Health Not Exciting?
We’re happy investors have made money, but we're cautious about Encompass Health. Here are two reasons why you should be careful with EHC and a stock we'd rather own.
1. Shrinking Adjusted Operating Margin
Adjusted operating margin is an important measure of profitability as it shows the portion of revenue left after accounting for all core expenses – everything from the cost of goods sold to advertising and wages. It’s also useful for comparing profitability across companies because it excludes non-recurring expenses, interest on debt, and taxes.
Analyzing the trend in its profitability, Encompass Health’s adjusted operating margin decreased by 4 percentage points over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its adjusted operating margin for the trailing 12 months was 16.7%.
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 2.2 percentage points over the last five years. It may have ticked higher more recently, but shareholders are likely hoping for its margin to at least revert to its historical level. If the longer-term trend returns, it could signal increasing investment needs and capital intensity. Encompass Health’s free cash flow margin for the trailing 12 months was 13.5%.
Final Judgment
Encompass Health isn’t a terrible business, but it doesn’t pass our quality test. With its shares topping the market in recent months, the stock trades at 24.2× forward P/E (or $120.20 per share). Beauty is in the eye of the beholder, but our analysis shows the upside isn’t great compared to the potential downside. We're fairly confident there are better stocks to buy right now. We’d recommend looking at the most entrenched endpoint security platform on the market.
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