The recent price drop at CVS Health (CVS) has caught my attention. As earnings at the pharmacy chain have continued to grow, the stock price has fallen from $113 to $81 in the past years as investors have needed to readjust their sanity in valuing the stock.
Last year, it was trading at $113 per share compared to trailing earnings of $4.51. This was a silly high valuation of 25x earnings for a healthcare retailer. About $5 billion in profits should have in no way justified a valuation of $124 billion. The business was incredibly strong, and was delivering impressive growth, but the stock had reached a point that was nearly double what it was worth.
Since then, earnings have continued their march forward, with CVS expected to earn $5.75 per share by the end of 2016. The stock has fallen 28% in the past year, and the stock price of $81 means that your entry point for the stock is only 14x earnings. That puts the stock at the low end of its historical valuation range, even while the business fundamentals of double-digit growth continue.
Meanwhile, you have people like this guy say “When will the nightmare end?” as he likely purchased the stock at some point in the last year and saw a quarter of his initial investment disappear quickly.
He bought the stock at a high, had to forfeit 25% to 30% as a consequence of his action, and will now earn results that mirror the business performance and might even get a little bit of P/E expansion thrown in. The investors that buy the stock here at $81 are getting a much better deal than was recently available, so the admonition that past returns won’t guarantee future returns is especially apropos here.
This is why I tell you to stay away from things like Post Holdings right now. This story of overvaluation burning off, and causing losses as a result, is a story that plays out over and over again. As things stand now, I imagine that CVS is one of the best stocks you can buy right now and it will almost certainly beat the S&P 500 from this point forward. It is trading at 14x earnings, paying out 2% in dividends, and growing profits at 12% annually. The conditions are ripe for 15% annual compounding, as the terms for new CVS shareholders are much better than what the market offered last year.
Originally posted 2016-11-03 16:22:21.