Insulet Corporation: Investment Thesis
Based on a closing share price of $162.83 as of October 1, 2019, and analysts’ consensus estimates, Insulet Corporation (PODD) is unlikely to provide attractive rates of return over the next five years unless its P/E ratio remains well above the sector median. The company itself appears well-managed with prospects for continuing strong revenue growth and improving margins. The shares, however, appear to be considerably overpriced at present. From the beginning of January through June 30, 2019, the share price increased by 63%, from $73.43 to $119.38. From the end of June through October 1, 2019, the share price has grown by a further 36% to $162.83. Part of the share price growth is undoubtedly due to the company starting to generate positive results after years of losses. But another likely cause of share price increases could be very temporary. Insulet has recently completed a new 0.375% Senior Convertible Note Offering redeemable in 2026, with most of the proceeds being used for early redemption of existing 1.25% Senior Convertible Notes redeemable in 2021. The company noted in its 8-K filing of September 3, 2019:
The terms of any repurchases of the 2021 Notes will depend on several factors including the market price of the Company’s common stock and the trading price of the 2021 Notes at the time of such repurchases. The consideration for any such repurchases may include cash, shares of the Company’s common stock, or a combination thereof. This activity could affect the market price of the Company’s common stock and the initial conversion price of the Notes. The Company expects that holders of the 2021 Notes that sell their 2021 Notes in such repurchases may purchase shares of the Company’s common stock in the market to unwind their hedge positions in connection with such repurchases, which could increase the market price of the Company’s common stock and the initial conversion price of the Notes.|
(Note: Bolding by author)
The early redemption of the whole of the 2021 notes will not be completed until October 25 or soon after. It would appear there could be an opportunity to short Insulet shares at the present price levels. At the same time, the company itself appears to present a good investment growth opportunity at the right entry price. Patience waiting for a lower share price could be rewarded. Using the 1View∞Scenarios Dashboard, I show assumptions and calculations of potential rates of return at targeted share price levels for entry to an investment in Insulet.
(Source: Insulet Corporation)
Insulet: Historical And Projected Future Shareholder Returns
In this article, I hope to show how targeting a desired return on an investment in shares can be facilitated by actually estimating what future returns will be, based primarily on analysts’ EPS estimates and other publicly available data.
Firstly, I provide details of actual rates of return for Insulet shareholders investing in the company over the past 4-5 years.
Insulet: Historical Shareholder Returns
Table 1 – Insulet: Historical Shareholder Returns
For many stocks where I create a table similar to Table 1 above, I find a wide range of returns, indicating a degree of volatility and risk. Table 1 above shows the results for Insulet were all positive for nine different investors, each investing $3,000 over the past five years and holding to the present. The average yearly rates of return range from 28.7% for investor A to 105.3% for investor H. These rates of return are not just hypothetical results, they are very real results for anyone who purchased shares on the various dates and held through to October 1, 2019. In considering which investor in Table 1 has achieved the best investment returns, we must take into account not only the percentage rate of return but also the “duration” of the investment. Investor H has the highest rate of return at 105.3%, and the investment has grown by $3,158, from $3,000 to $6,158. If Investor H continues to hold but Insulet share price remains around current levels, the percentage rate of return will decrease the longer the shares are held, due to the effect of duration. Investor D’s average yearly rate of return at 61.8% is lower than that of Investor H. But due to duration, Investor D’s investment has grown by $13,154, over four times the growth in Investor H’s investment. Of course, Investor D has had their funds tied up since Q2 2016. Investor H has likely had their funds invested elsewhere between Q2 2016 and Q4 2018. But those funds would have required rates of return ~60% to match Investor D’s investment performance. Long duration coupled with high rates of return are very powerful allies for investors.
Insulet: Projecting Future Shareholder Returns
If rate of return is the basis on which we judge the performance of our investments, then surely we should be seeking to estimate future likely rates of return when we are making investments. But how do we do that? Analysts’ Corner uses its proprietary models to generate net income, balance sheet/cash flow and projected rates of return going out five years. Much of this is automated, but still involves a great deal of research and business and data analysis to back up the projections. We will undertake this detail where subscribers have identified promising companies that are under-covered by analysts. We also will undertake this detail where we believe the analysts covering a stock have missed some important aspect and we believe the market will be surprised come earnings release time. Recent cases where market surprises have been identified can be found in these articles – “RH: Expect A Strong Q1 Beat – Trigger For A Massive Short Squeeze” and “Sleep Number: Expect A Strong Second Quarter EPS Beat And Increased Full-Year Guidance.” Now, all of that takes a lot of effort, with the end result often not clear until after the work is done. Before we get into that level of detail, we are able to use our high-level models to project indicative future rates of return for individual stocks, as explained below. Let us first look at the traditional approach to assessing value of a stock for investment purposes.
Insulet: Qualitative Assessment Of Value Grade For Share Investment Decisions
Figure 1 below is based on data from Seeking Alpha Premium.
(Data Source: Seeking Alpha Premium Valuation Metrics)
As can be seen, Figure 1 is a qualitative assessment of Insulet providing an overall value grade of “F” for share investment at the current share price. Seeking Alpha Premium also provides analysts’ estimates of EPS for Insulet as per Figure 2 below.
Figure 2 – Summary Of Analysts’ Adjusted Non-GAAP EPS Estimates
I incorporate analysts’ EPS estimates from both SA Premium and from Zacks Research into the averages I adopt for EPS estimates. There always are issues with using analysts’ quarterly and yearly EPS estimates together. Not all analysts provide quarterly estimates, so the number of analysts will be different for quarters and year. This is part of the reason the quarterly estimates seldom add up to the yearly estimates. Another reason is the analyst providing the “high” estimate for a given year might not also be the one with the highest estimate for each and every quarter of that year. Accordingly, I give priority to the yearly EPS averages and pro-rate the quarterly EPS estimates to ensure they add to the yearly total. This massaging might seem pedantic, but the differences between quarters and years can be large and the process is automated.
Similar to the value grading per Figure 1, EPS and EPS growth estimates are qualitative in nature and do not quantify the rate of return that can be expected for the stock in question.
Insulet: Quantitative Assessment Of Value For Investment
Before developing our own detailed estimates of future earnings, cash flows, etc., for a given company, we can quantify the range of potential rates of return utilizing analysts’ estimates of EPS available from Seeking Alpha Premium, Zacks Research through Nasdaq, and other qualitative data per Figures 1 and 2 above. Table 2 below shows our 1View∞Scenarios Dashboard developed for this purpose, and in this case, we use the dashboard to quantify potential rates of return from an investment in Insulet at the closing share price as on October 1, 2019.
Table 2 – 1View∞Scenarios Dashboard Insulet Projected Rates Of Return
The dashboard elements
The Dashboard will hopefully seem less daunting if I first walk you through it from top to bottom.
- Analysts Estimates non-GAAP EPS TTM – The EPS amounts come straight from Figure 2 above.
- P/E Ratio Non-GAAP EPS TTM basis – Through the end of FY 2019, the P/E figures are calculated by dividing actual/projected share price by actual/projected EPS. For FY2020 to FY2023, the P/E ratio is input through the assumptions section further down in Table 2.
- Share price at buy date/end date – The buy date share price is the price at which you are targeting to buy the shares. It’s either the current share price or the lower-entry share price you are targeting per the assumptions further down in Table 2. The end share price is the calculated share price at the end of the period for which you are planning to hold your investment.
- Rate of Return (IRR) – This is the projected rate of return you will achieve based on the assumptions that have been input. Insulet does not pay a dividend, but for tickers that do, a rate of return based on dividends reinvested also is provided. The rates of return calculated here are calculated on an identical basis to the actual rates of return per Table 1 above.
- Current share price – This is a direct input that can be changed from day to day as the share price changes.
- Change start share price – This allows changes to the starting buy share price if the current share price does not indicate a satisfactory rate of return for your requirements. Particularly, with a ticker showing a degree of volatility, there can be opportunities to buy at a lower share price than the current share price. This function allows to determine in advance at what share price you would find the indicative rate of return attractive (see also worked example further below).
- Share price over current price/previous quarter – This allows to project a higher or lower share price at the end of or during Q4-19, by adjusting share prices by a percentage up or down. In Table 2 above, I have input assumptions that the share price will increase by 2.45% by the end of Q4.
- P/E ratio (adjusted non-GAAP EPS basis) – Rather than modeling share price changes by a percentage increase or decrease, share prices for FY 2020 to 2023 are projected on the basis of multiplying assumed P/E Ratio by Analysts’ EPS estimates for each year. The Base P/E Ratio assumption for FY 2020 to FY 2023 is adopted from the “P/E Non-GAAP (TTM) Sector Median” figure of 22 per Figure 1 above.
- Other outcomes for shareholders show the proceeds projected to be received from the investment and projected share price growth rates based on the input assumptions.
Modeling For Targeted Returns Using The Dashboard
In the dashboard above, I am targeting ~10% per year return from an investment in Insulet at the current share price of $162.83. My EPS assumptions are drawn from the analysts’ consensus, high, and low estimates per Figure 2. My share price estimates for 2020-2023 are a function of multiplying the various EPS figures by P/E ratio. The base P/E ratio starts with the sector median non-GAAP (TTM) P/E ratio of 22 per Figure 1 above. The variable in this return targeting exercise is the P/E ratio. I adjust the P/E ratio until the rate of return for each of the consensus, high, and low EPS scenarios is ~10% for all years 2020-2023. What I find in Table 2 above is in order to achieve the desired rates of return of ~10%, I have to assume high P/E ratios all the way through to the end of 2023. The required P/E ratios for 2023 are Consensus case 72.0, High case 69.0, and Low case 75.0. Those P/E ratios are far lower than the current P/E ratio of over 570.0, but still far above the sector median of 22. I need to see the possibility in the years after 2023 of achieving a 10% per year rate of return based on an ending share price with an ending P/E ratio no higher than the sector median of 22. That could take a long time. To continue to earn a 10% rate of return on the shares and for the P/E ratio to reduce to 22.0 by 2030, EPS would have to grow by a CAGR of 30% from the end of 2023 to end of 2030.
I am attracted to the company, its products, and the way it conducts its business. But if I accept the analysts’ range of EPS estimates, the only way I can achieve my desired rate of return at lower ending P/E ratios is to target buying the shares at a lower share price.
Insulet: Targeting A Satisfactory (To You) Return On Investment
The problem with waiting until shares are cheap to buy is they may have become cheap because the outlook for the stock and its earnings has worsened. But there can be considerable volatility in the price of shares with no discernible change in outlook, as shown in Figure 3 below.
As recently as January 2019, there were opportunities to buy Insulet shares under $80, and as recently as July, the share price was under $120. I believe the current share price has been driven up by overexuberance. It’s possible the opportunity to buy at $120 and lower will arise again in the weeks and months ahead. Using the 1View∞Scenarios Dashboard, I’m able to see the effect on projected rates of return of buying Insulet shares ~$120 in Q4 2019.
Timing Stocks Versus Timing The Market
Table 3 – 1View∞Scenarios Dashboard Insulet Projected Rates Of Return
In Table 2, buying at the current share price would require what appear to be excessively high P/E ratios of 69.0-75.0 in order to target returns ~10% per year. Per Table 3, buying around ~$120 within the past three months or waiting to buy ~$120 at a future date maintains the indicative return at ~10%, but with lower P/E ratios of 51.0-56.0 at the end of 2023. Targeting to buy stocks at a favorable entry price is quite different from, and should not be confused with, timing the market. Timing the market requires you to increase or decrease the total value of your portfolio of stocks depending on the direction that you perceive the market is heading in. Regardless of where the market is heading, individual share prices fluctuate independent of market movement.
Whether building or re-weighting a portfolio, targeting favorable prices for share additions does not require periods of not buying at all. With 1View∞Scenarios Dashboards set up for each of the stocks in your portfolio, it is possible to select for additional purchases those stocks in your portfolio that presently have the most favorable indicative future return at current or targeted share prices.
Insulet Corporation: Conclusions
Based on the closing share price of $162.83 as on October 2, 2019, and on analysts’ consensus estimates, and assuming a P/E ratio around the sector median, Insulet is very overpriced at present. At the current share price, shorting could be appropriate. At a significantly lower share price, Insulet could represent a valuable investment in a strong company with excellent growth prospects.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor and/or a tax advisor as to the suitability of such investments for their specific situation. Neither information nor any opinion expressed in this article constitutes a solicitation, an offer, or a recommendation to buy, sell, or dispose of any investment, or to provide any investment advice or service. An opinion in this article can change at any time without notice.