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Beware of Headlines (Including This One)

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Two headlines. Two very different implications. That's what you would have found if you looked for news on the quarterly results for leading pharmacy benefit management (PBM) company Express Scripts (Nasdaq: ESRX  ) . Here are two of the headlines:

"Express Scripts 2Q profit falls 49 percent" – AP

"Express Scripts Earnings: Strong Margins Continue, Stock POPS" – Wall St. Cheat Sheet

The first headline sounds like horrible news. The second headline sounds like wonderful news. Which is correct? Actually, both are.

Profit falls?
The first headline wasn't false. Express Scripts' second-quarter earnings did fall by 49% compared to the same quarter last year. Net income from second quarter of 2012 totaled $170.9 million, versus $334.2 million in 2011. Diluted earnings per share dropped from $0.66 in 2011's second quarter to $0.21 in 2012. Bad news? Not really.

The reason that Express Scripts' earnings fell is that the company closed on its acquisition of rival PBM Medco in the last quarter. Adjusted earnings per share, which add costs related to the acquisition back in, were to $0.88, according to the company. These adjusted earnings reflect an increase of nearly 24% in the second quarter of 2012, compared to adjusted earnings for 2011.

Strong margins continue?
Did Express Scripts show strong margins during the second quarter, as the other headline indicated? Yes -- and no.

Gross profit margin increased to 7.8% from 7.1% in 2011. If you consider those levels to be strong, then the headline is on target. Relative to Express Scripts' gross margins over the past couple of years, 7.8% isn't too shabby.

If you compare this number to other stocks, though, you would probably arrive at a different conclusion. A simple screen that I ran found more than 5,500 stocks with gross profit margins higher than Express Scripts' margin. Only 899 stocks had lower gross profit margins.

Net profit margin is also a different story. Using GAAP earnings, Express Scripts had a net profit margin of 2.2%. The company's five-year average net profit margin is 3%.

Perhaps these margins could be viewed as strong when compared to rival PBMs. Catamaran (Nasdaq: CTRX  ) , for example, has a trailing 12 month profit margin of only 1.74%.

Using adjusted earnings would also help justify the strong margins argument.

The real story
The real story lies beyond those headlines. As the second headline stated, shares did pop -- rising around 8% after the earnings announcement. One major reason for the stock's increase is that Express Scripts increased earnings guidance from $3.36-$3.66 per share to $3.60-$3.75 per share.

The recent resolution of the company's dispute with Walgreen (NYSE: WAG  ) undoubtedly helped. Express Scripts has not carried Walgreen in its pharmacy network in 2012 thus far because of the dispute, but it will do so again beginning in September. While the company maintains that it retained at least 95% of customers during this period, a new contract between the two players is good news for shareholders.

Express Scripts cited a solid start with the Medco integration as a contributing factor in its positive outlook. The combination of the two PBMs puts Express Scripts in a dominant position in terms of size versus other PBMs like CVS Caremark (NYSE: CVS  ) and Catamaran. Management expects to achieve $1 billion in synergy through the acquisition.

Another big plus helping Express Scripts and the other PBMs is the so-called "patent cliff" impacting several highly used drugs. Major pharmaceutical companies such as Pfizer (NYSE: PFE  ) lost exclusivity on several blockbuster drugs because of patent expiration. That's bad news for Pfizer and others as companies like Israel-based Teva Pharmaceutical (Nasdaq: TEVA  ) step in to make generic versions.

This patent cliff is great news for generic manufacturers such as Teva -- and for PBMs. Increased availability of generics resulting from this shift benefits PBMs because the generic drugs have a higher profit margin. Express Scripts noted that its generic utilization rate increased in second quarter to 77.4% compared to 73.9% in the same quarter last year.

The problem with relying solely on the headlines is that they only present a snippet of the whole story. Unfortunately, some do make investing decisions off of headlines at times in an effort to execute trades more quickly.

Foolish investors dig. We plow through the earnings releases and SEC filings. We listen to the company conference calls. And then we make our call on a company in light of all the facts at hand.

By the way, many of the headlines about Express Scripts mentioned both the earnings drop and that the decline was due to the Medco acquisition. That's why you should even beware the headline on this article.

Beware is simply another way to say "be aware." There are some stocks you can be aware of that Wall Street is overlooking in large part. Check out The Motley Fool's new report "Middle-Class Millionaire-Makers: 3 Stocks Wall Street's Too Rich to Notice." Get your free copy now!

Fool contributor Keith Speights owns no shares in the stocks mentioned above. The Motley Fool owns shares of Catamaran and Express Scripts Holding. Motley Fool newsletter services have recommended buying shares of Catamaran, Pfizer, and Express Scripts Holding. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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