United Healthcare, a health maintenance organization, is expected to have earnings growth of 30% for the next five years and 6% after that. The dividend payout ratio will be only 10% during the high growth phase, but will increase to 60% in steady state. The return on equity was 21% in the most recent time period. The stock has a beta of 1.65 currently, but the beta is expected to drop to 1.10 in steady state. (The treasury bond rate is 7.25%.)
(a) Estimate the price/book value ratio for United Healthcare, given the inputs above.
(b) How sensitive is the price/book value ratio to estimates of growth during the high growth period?
(c) United Healthcare trades at a price/book value ratio of 7.00. How long would extraordinary growth have to last (at a 30% annual rate) to justify this PBV ratio.
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