Will these 2 stocks give you a healthy return?

Medibank Private Ltd (ASX:MPL) has fallen close to its IPO price – Is now a good time to buy?

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There is little doubt the government was successful in creating a lot of buzz around the Medibank Private Ltd (ASX: MPL) float. The stock jumped on the first day of trading and eventually reached a high of $2.59 in late February. The stock has been in a strong downtrend since and is now trading close to its IPO price of $2. Many retail investors will be hoping this is just a temporary fall, but has this presented a good buying opportunity?

Medibank Private is Australia’s largest private health insurer. While the long-term sector fundamentals remain strong, the company has been priced for strong short-term earnings growth. Investors have been expecting operating costs would be reduced dramatically once the company was in private hands but this has not eventuated and there are increasing concerns revolving around competition from other providers in the sector.

It seems the market may have been caught up with the hype around the IPO and not looking further into the fundamentals. According to analysts’ forecasts, Medibank Private is priced at around 22x FY15 earnings. This is not cheap considering the private health insurance market is only growing at a moderate pace and increased claim inflation is making premium increases less affordable for consumers. Competition has become more fierce and churn rates have increased throughout the industry making it difficult for Medibank Private to increase market share.

NIB Holdings Limited (ASX: NHF) has been a strong performer over the last five years but its valuation is also looking stretched. The company is also trading around 22x forecast FY15 earnings with a dividend yield of less than 3%. Although group premium revenue has grown strongly over the past 7 years as a result of premium increases each year, NIB’s operating profit has been unable to maintain the same pace more recently. Claims growth has been considerable as a result of increasing health costs and an increasing number of claims.

Comparing the two stocks, NIB would be my preferred company. It is taking share from other health insurers in Australia and expanding its operations in New Zealand. It is also investing in adjacent businesses which could drive its growth in the future. I would however, be waiting for further share price falls before investing in either company as both look fully priced at current levels.

Foolish takeaway

The healthcare sector is expected to grow more rapidly than the general economy over the next 20 years and beyond. The costs to government will inevitably become unsustainable and as a result private health insurers will play an increased role in funding the health needs of an ageing population. NIB and Medibank Private will both play an ever-increasing role in the sector but this will also create challenges for both companies as increasing costs and competition make it harder to maintain their current margins.

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Motley Fool contributor Christopher Georges has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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