The past six months have been a windfall for Evolent Health’s shareholders. The company’s stock price has jumped 48.6%, hitting $3.70 per share. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Evolent 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 Evolent Health Not Exciting?
We’re happy investors have made money, but we’re passing on Evolent Health for now. Here are three reasons you should be careful with EVH, plus one stock we’d rather own.
1. Weak Sales Volumes Indicate Waning Demand
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 Healthcare Technology for Providers company because there’s a ceiling to what customers will pay.
Evolent Health’s average lives on platform came in at 75.64 million in the latest quarter, and over the last two years, averaged 3.2% year-on-year growth. This performance slightly lagged the sector and suggests it might have to lower prices or invest in product improvements to accelerate growth, factors that can hinder near-term profitability. 
2. New Investments Fail to Bear Fruit as ROIC Declines
We like to invest in businesses with high returns, but the trend in a company’s ROIC can also be an early indicator of future business quality.
Over the last few years, Evolent Health’s ROIC has unfortunately decreased significantly. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
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.
Evolent Health’s $970.4 million of debt exceeds the $115.7 million of cash on its balance sheet. Furthermore, its 7× net-debt-to-EBITDA ratio (based on its EBITDA of $126.9 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. Evolent Health 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 Evolent Health can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
Evolent Health’s business quality ultimately falls short of our standards. After the recent rally, the stock trades at 10.5× forward P/E (or $3.70 per share). This valuation multiple is fair, but we don’t have much faith in the company. We’re pretty confident there are more exciting stocks to buy at the moment. We’d suggest looking at the most entrenched endpoint security platform on the market.
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