The past six months haven’t been great for Select Medical. It just made a new 52-week low of $15.71, and shareholders have lost 55.5% of their capital. This was partly due to its softer quarterly results and might have investors contemplating their next move.
Is there a buying opportunity in Select Medical, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Even with the cheaper entry price, we're sitting this one out for now. Here are three reasons why you should be careful with SEM and a stock we'd rather own.
Why Is Select Medical Not Exciting?
Founded in 1996, Select Medical (NYSE:SEM) operates critical illness recovery hospitals, rehabilitation hospitals, outpatient rehabilitation clinics, and occupational health centers across the US.
1. Demand Slipping as Sales Volumes Decline
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 Outpatient & Specialty Care company because there’s a ceiling to what customers will pay.
Select Medical’s admissions came in at 8,691 in the latest quarter, and they averaged 1.1% year-on-year declines over the last two years. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Select Medical might have to lower prices or invest in product improvements to grow, factors that can hinder near-term profitability. 
2. Revenue Projections Show Stormy Skies Ahead
Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.
Over the next 12 months, sell-side analysts expect Select Medical’s revenue to drop by 17.4%, a decrease from its 2.3% annualized growth for the past two years. This projection doesn't excite us and suggests its products and services will see some demand headwinds.
3. 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, Select Medical’s margin dropped by 11.5 percentage points over the last five years. If its declines continue, it could signal increasing investment needs and capital intensity. Select Medical’s free cash flow margin for the trailing 12 months was 4.5%.
Final Judgment
Select Medical isn’t a terrible business, but it doesn’t pass our bar. After the recent drawdown, the stock trades at 14.4× forward price-to-earnings (or $15.71 per share). Investors with a higher risk tolerance might like the company, but we don’t really see a big opportunity at the moment. We're pretty confident there are superior stocks to buy right now. We’d suggest looking at a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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