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 CVS Caremark (NYSE: CVS ) 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 CVS Caremark.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||15.3%||Pass|
|1-Year Revenue Growth > 12%||16.0%||Pass|
|Margins||Gross Margin > 35%||18.3%||Fail|
|Net Margin > 15%||3.2%||Fail|
|Balance Sheet||Debt to Equity < 50%||24.8%||Pass|
|Current Ratio > 1.3||1.47||Pass|
|Opportunities||Return on Equity > 15%||9.7%||Fail|
|Valuation||Normalized P/E < 20||15.80||Pass|
|Dividends||Current Yield > 2%||1.4%||Fail|
|5-Year Dividend Growth > 10%||25.3%||Pass|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at CVS Caremark last year, the company has picked up an extra point. With a big boost in revenue, the stock is also up about 40% in the past year.
CVS has had an excellent year, due in part to the struggles of its major rival. Walgreen (NYSE: WAG ) spent much of 2012 in a dispute with Express Scripts (Nasdaq: ESRX ) , which left Express Scripts customers scurrying to CVS and Rite Aid (NYSE: RAD ) to get prescriptions filled. Now that the dispute has ended, however, those tailwinds will likely go away.
In addition, CVS has recently given investors some mixed signals. On one hand, the company had an excellent second quarter, with revenue setting a new record and a 25% increase in adjusted earnings coming from 5.6% high same-store sales figures. But some are skeptical about the higher figures, noting that the company's buyout of the Medicare business of Universal American should have had a big positive impact on sales and earnings. That may be why shares fell after the announcement.
One interesting trend in the industry has to do with Medicare and Medicaid business. With the buyout earlier this week of Coventry Health Care (NYSE: CVH ) by Aetna, pharmacy benefits management will be a big deal for CVS, as it provides services for Aetna while Express Scripts works with Coventry. Similar episodes will likely play out in the coming months and years if consolidation continues.
For CVS to keep improving, it needs to continue to focus on revenue growth and work toward boosting return on equity, perhaps by expeditious use of debt. A higher dividend would also go a long way toward CVS matching Walgreen and getting closer to perfection.
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.
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