How will the lawsuit affect the valuation multiples (P/E, EV/EBITDA) used in my valuation model?
Impact on valuation multiples
The securities‑fraud suit against Centene adds a material “event‑risk” premium to the equity side of the model. Even before any judgment, the market will price‑in a higher probability of a future cash‑flow hit (potential fines, remediation costs, or a drop in enrollment growth). As a result, the share price is likely to be bid down on the news, compressing the P/E ratio (price falls while earnings remain unchanged) and expanding the EV/EBITDA multiple (EV falls with a relatively stable EBITDA). In practice you can expect a 5‑10 % discount to the pre‑news multiples for a company of Centene’s size and a negative‑sentiment rating of –75, with the discount widening if the case proceeds to a settlement that materially reduces projected cash‑flows.
Trading implications
- Short‑term: Anticipate heightened volatility and a downside bias. A modest short position or a protective put can capture the expected multiple contraction while you wait for the price to settle after the initial reaction.
- Medium‑term: If the lawsuit materialises into a concrete liability, re‑run the DCF with a higher discount rate (≈ 8‑10 % vs. the current 7 %) and a downward‑adjusted free‑cash‑flow growth line. The revised fundamentals will justify a lower terminal multiple, reinforcing the short‑bias or prompting a position‑size reduction.
- Long‑term: Should the case be dismissed or result in a minimal settlement, the “event‑risk” premium will evaporate, allowing multiples to revert toward historical averages (P/E ≈ 12‑14×, EV/EBITDA ≈ 8‑9× for the sector). In that scenario a contrarian long could be added on the bounce back to the mean.
Actionable take‑away: Adjust your valuation model now by applying a 5‑10 % discount to both P/E and EV/EBITDA to reflect the lawsuit risk, and monitor the case’s progression. If the price slides into the discounted range, consider a short or a hedged position; if the risk premium is priced out and the case weakens, be ready to flip to a long once multiples start to normalize.