Diversified managed care players remain healthy investments despite the woes of their Medicaid-only peers.

That's the view offered by Wall Street analysts, anyway, after

Amerigroup

( AGP) this week issued a profit warning that sent its stock plummeting by more than 40%.

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For investors in Amerigroup -- and even competing Medicaid insurers such as

Centene

(CNC) - Get Report

and

Molina

(MOH) - Get Report

-- the news couldn't get much worse. Amerigroup now expects to report a third-quarter loss instead of the 48-cent profit that analysts had anticipated. Much of the shortfall stems from a spike in care for sick newborns and those seeking outpatient services. But more than half of it comes from medical costs that wound up underreported in the first half of the year.

Thus, Amerigroup earned even less than Wall Street expected when the company posted disappointing quarterly results last time around. By now, some believe, management has suffered lasting damage as a result.

"The company was the first Medicaid-focused managed care organization to go public and -- with a three-year track record of solid financial performance while navigating challenging regulatory environments -- Amerigroup was viewed broadly as an industry leader," noted Lehman Brothers analyst Gregory Nersessian on Friday. But "following two consecutive earnings shortfalls, evidence of reserve mismanagement and the communication of mixed signals to investors at recent industry events, we believe that investors will be less likely to give management the benefit of the doubt going forward."

Nersessian himself has clearly lost faith. He cut his recommendation on the stock from overweight to equal-weight and his price target by virtually half to $21.

The stock, down another 4% on Friday's downgrade, recently fetched $18.97.

Immune System

Still, analysts see no similar problems for more traditional managed care players -- even those, such as

Humana

(HUM) - Get Report

, with big Medicaid units of their own. Indeed, they suggested buying selected names on any weakness in the broader group.

"We believe the cost trend and other problems at Amerigroup and Molina (which has suffered its own shortfall) are mostly company-specific driven by overly aggressive expansion within the Medicaid sub-sector of managed care," explains Goldman Sachs analyst Matthew Borsch, who has a neutral rating on the managed-care group overall. "Beyond the specific expansion strategies at those two companies, we also highlight that the reimbursement and utilization dynamics within Medicaid are quite different from commercial or Medicare, and that we have no signs of more widespread signs of an uptick in cost trends or industrywide reserving issues."

Prudential analyst David Shove tends to agree.

Shove believes that the Medicaid-only business model suffers from unique flaws. Notably, he says, the Medicaid-only insurers have come under pressure from states to build vast provider networks that make effective cost controls quite difficult. Moreover, he says, those same states dictate reimbursement levels and therefore leave the Medicaid companies highly vulnerable to any unexpected spikes in medical costs.

In contrast, Shove says, commercial managed care companies seek tight control over both provider networks and pricing and -- not surprisingly -- lose their bids for some state contracts as a result.

Bear Stearns analyst John Rex echoes that theme. He believes the Medicaid players now carry some of the same risks that fast-growing commercial insurers once did.

"The Medicaid group has been a growth story ... with the market very focused on enrollment -- and the stocks at one point garnering a very significant premium," writes Rex, who has an overweight rating on the managed care sector in general. "Issues of predictability and actuarial precision remind us of the (then new) commercial sector in the mid-1990s and highlight the risks of some of the less-developed players."

Since then, of course, traditional managed care players have moved on and enjoyed quite a run. Thus, Rex suggests sticking with the biggest of those -- specifically

Aetna

(AET)

,

UnitedHealth

(UNH) - Get Report

and

WellPoint

(WLP)

-- going forward. He has no rating on the Medicaid-only players at all.

Meanwhile, Borsch recommends both Aetna and

Health Net

(HNT)

. He believes that managed care stocks, in general, should keep rising through at least the first half of next year. After that, however, he sees potential challenges. For example, he worries about smaller benefits from mergers and Medicare opportunities going forward. And he still believes a cyclical downturn will come.

However, he concludes, "our view is that the next commercial underwriting cycle downturn -- while inevitable -- will likely not set in until 2007 or later."