Cheap, dividend-paying stocks with free embedded call options. #1 CVS
My investment strategy now involves finding cheap, dividend-paying stocks that have some sort of free embedded call option that could act as a catalyst for significant earnings improvement down the road.
While its dividend isn't as high as I normally like (around 1%), CVS is much cheaper than its main competitors. Looking at the stock at a simplistic level and comparing its P/E ratio to its main competitors we see that CVS currently trades at around 14.4 times its real trailing earnings (not some analyst's guess of how it will do in the future). That compares very favorably to its number one competitor in the pharmacy segment, Walgreen (WAG) which trades at around 17 times trailing earnings (I'm ignoring the mess that is Rite Aid).
The great thing about CVS is that it's not just a pharmacy, it also engages in pharmacy benefit management (PBM) through its Caremark division. PMBs are hot, hot, hot. Take a look at companies like Express Scripts Inc. (ESRX), which trades at over 33 times trailing earnings, or Catalyst Health Solutions (CHSI), which trades at 30 times.
Granted, Caremark hasn't exactly been knocking the cover off the ball to use a baseball analogy (heck it is spring after all), but its business seems to have stabilized. Anyone who uses Caremark now has made a conscious decision to do so because their contract likely had to be renewed so we are unlikely to see any mass client defections in the near future. Besides Caremark has been left for dead by investors. It's super cheap compared to its competitors.
Now onto the good part, the caralysts. They include the following:
- The likely influx of new customers created by the expansion of healthcare that the government recently passed.
- Increased profitability as a result of the coming wave of generic drug introductions, which are more profitable for pharmacies and PBMs than branded medications.
- A demographic tailwind from aging customers who will need more medicine.
So there you have it. A cheap, dividend-paying stock, with specific event driven catalysts that could significantly improve the company's results, and in turn its stock price in the years ahead. The majority of my personal portfolio now consists of companies like this. If I find some time, I'll write up a short blurb on another one.