The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.NEW YORK ( MagicDiligence.com) -- We believe defense contractors, home health agencies and for-profit education could face disproportionate hits from spending pullbacks as a result of the just-passed debt deal. The deal allows the federal government to raise the debt ceiling by $2.4 trillion. To balance this act, there is an initial $917 billion in spending cuts over the next 10 years. Additionally, a congressional committee will be appointed to find another $1.5 trillion in spending to cut, by Thanksgiving of this year. If the committee does not come to an agreement, a pre-arranged set of spending cuts will kick in (the "trigger cuts"). Let's take a look at the current Magic Formula stocks in three well-represented Magic Formula Investing sectors that are now at risk.
The two current ones are Almost Family ( AFAM) and industry leader Amedisys ( AMED). Both of these companies rely on Medicare reimbursements for more than 80% of revenue, with state-run Medicaid a significant portion of the balance. This leaves them hugely dependent on Medicare reimbursement rates for their financial well-being. We've already seen cuts from the "ObamaCare" plan passed last year. Reimbursements to home health fell by more than 5% this year, with another similar cut for 2012. Medicare is rumored to face cuts if the "trigger" plan kicks in. The ultimate effect here is less certain than in defense. Medicare cuts are a politically sensitive issue, and the program is already squeezing this sector. Home health care is a cost-effective alternative to hospital and nursing home care, so it might be able to avoid additional scrutiny.
Valuations in the defense sector are extremely low. Northrup is at its lowest valuation in over a decade, while Lockheed and Raytheon are at the bottom of their historical ranges. What's more, many of these firms pay large, well-supported dividends. Lockheed pays 4%, Raytheon 3.8% and Northrup 3.3%. I would avoid non-payers such as SAIC and OshKosh, at this point. Valuations in home health are even lower. Both AFAM and AMED trade at a P/E ratio barely above 7. These are bankruptcy valuations, but the truth is that both of these firms have both organic volume growth, and have the opportunity to consolidate a large and fragmented market. The selloff looks overdone.