Has Medco Health Solutions Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Medco Health Solutions (NYSE: MHS  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Medco Health Solutions.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

10.3%

Fail

 

1-Year Revenue Growth > 12%

7.3%

Fail

Margins

Gross Margin > 35%

6.6%

Fail

 

Net Margin > 15%

2.1%

Fail

Balance Sheet

Debt to Equity < 50%

146.2%

Fail

 

Current Ratio > 1.3

0.68

Fail

Opportunities

Return on Equity > 15%

34.1%

Pass

Valuation

Normalized P/E < 20

13.20

Pass

Dividends

Current Yield > 2%

0%

Fail

 

5-Year Dividend Growth > 10%

0%

Fail

       
 

Total Score

 

2 out of 10

Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.

When we looked at Medco Health Solutions last year, it had a slightly better score of three. With revenue growth having slacked off a bit over the past year, Medco finds itself a bit further from perfection but on the cusp of a major transformation.

A lot has happened in the pharmacy benefits management space since we looked at Medco last year. The biggest trend has been consolidation. Catalyst Health Solutions (Nasdaq: CHSI  ) took over the PBM business of Walgreen (NYSE: WAG  ) , but the biggest move in the industry was Express Scripts (Nasdaq: ESRX  ) plan to buy Medco in a huge $29.1 billion deal.

With Medco reeling from the loss of contracts with California's CalPERS pension fund as well as UnitedHealth (NYSE: UNH  ) , it was clear that the company would benefit from economies of scale. The combination will give Medco and Express Scripts a huge lead over No. 2 CVS Caremark (NYSE: CVS  ) and put it in better position to win new contracts. With CVS having picked up Universal American's (NYSE: UAM  ) Medicare prescription drug business and holding a long-term contract with Aetna (NYSE: AET  ) , competition will definitely get more fierce in the years to come.

Although Medco's stock won't survive the merger, shareholders will receive some cash as well as shares of Express Scripts in the deal. For those who hold onto their Express Scripts shares, the stronger new company is poised to get a lot closer to perfection than Medco did on its own.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Click here to add Medco Health Solutions to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our 13 Steps to Investing Foolishly.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. Motley Fool newsletter services have recommended buying shares of Medco Health Solutions. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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