Is Walgreen Priced for Perfection?

Walgreen's share price has soared over the past year, but its earnings growth hasn't kept up. Here's why you might want to think twice before buying in at these levels.

Jun 10, 2014 at 6:00PM

Pharmacy operator Walgreen (NASDAQ:WBA) has a number of catalysts working in its favor. First and foremost is that fact that because of its status as the largest drugstore chain in the United States, it will surely profit from an aging population. Tens of millions of Americans are at or nearing retirement age, and as a person ages, their health-care needs increase. This will keep demand strong for Walgreen's products, especially in its pharmacy.

The market has woken up to these positive catalysts, and has sent shares of Walgreen soaring more than 50% over the past year. At the same time, its underlying fundamentals aren't as impressive as its share price performance. The end result is that Walgreen has a very lofty valuation that should be cause for concern over what the future holds. That's why you'd be wise to exercise a dose of caution before jumping into Walgreen at these levels.

A valuation that might make you ill
In addition, Walgreen is set to expand internationally, thanks to its $6.7 billion investment in Alliance Boots, the largest drugstore chain in the United Kingdom. Walgreen was solely a U.S.-based operator until the two parties combined two years ago. Immediate growth from the investment, in addition to cost synergies, is helping boost Walgreen's profitability.

However, it's also true that sometimes even a great company can become a poor investment if you pay too high a price for it. In Walgreen's case, that's a valid concern. The stock has rallied hugely over the past year and now holds a very lofty valuation. It's much more highly valued than the overall market as well as close competitor CVS Caremark (NYSE:CVS).

While Walgreen is a highly profitable and successful company operating in a business with good prospects for continued growth. That being said, here's why you should think twice before buying the stock at these levels.

Growth at an unreasonable price?
Walgreen is halfway through its current fiscal year, and the results so far are mixed. Revenue and earnings per share are up 5% and 22%, respectively. Walgreen's bottom line is getting a solid boost from the investment in Switzerland-based Alliance Boots . The combination has produced cost synergies totaling $236 million so far. Synergies are expected to reach approximately $400 million this year alone.

Plus, Walgreen is benefiting from strong prescription sales, which grew 7% last quarter. This is a great sign for Walgreen, since prescriptions make up nearly two-thirds of the company's total revenue. Moreover, Walgreen's share of all retail prescriptions rose 20 basis points last quarter, to 19%.

And yet, it seems like all this growth is more than priced into Walgreen's valuation. The stock has been on an unbelievable tear over the past year, which means you should be wary if you're considering buying in now.

After an incredible rally over the past year, Walgreen now trades for about 26 times trailing earnings. Walgreen's valuation multiple is well above its average multiple over the past several years. Walgreen's five-year average trailing P/E clocks in at 16 times, meaning it's now trading at a 62% premium to that. And, Walgreen's valuation stands at 19 times fiscal 2014 estimates.

This is a very aggressive valuation, especially considering analysts aren't expecting huge earnings growth this year. The median analyst expectation calls for $3.45 in adjusted earnings per share in fiscal 2014, which would represent 10% growth versus the previous year. That would certainly represent a successful year but not a performance warranting a 19 forward P/E multiple.

Its competitors are also not as aggressively valued as Walgreen. CVS is valued at about 20 times trailing earnings, a 23% discount to Walgreen. This is despite the fact that CVS posted 6% revenue growth and 23% earnings growth last quarter .

CVS is also valued at 15 times forward earnings estimates. It seems that there may be a disconnect between how the two close rivals are valued by Wall Street.

The Foolish bottom line
Walgreen is a highly profitable company that rewards its shareholders with reliable dividend increases every year. It's got a strong future ahead of it from an operational standpoint, thanks to the aging population in the United States and its investment in Alliance Boots. Walgreen is sure to profit from the rising health-care needs of the U.S. population and has international growth to look forward to as well.

However, it's rarely wise to throw caution to the wind when buying stocks. Walgreen's share price soared over the past year. Its earnings growth is expected to be fairly modest this year, which calls its huge rally into question. While it's easy to get swept up in a stock soaring to new highs seemingly on a daily basis, you may want to wait for a pullback before jumping into Walgreen right now.

Are you ready for this $14.4 trillion revolution?
Have you ever dreamed of traveling back in time and telling your younger self to invest in Apple? Or to load up on Amazon.com at its IPO, and then just keep holding? We haven't mastered time travel, but there is a way to get out ahead of the next big thing. The secret is to find a small-cap "pure-play" and then watch as the industry -- and your company -- enjoy those same explosive returns. Our team of equity analysts has identified one stock that's ready for stunning profits with the growth of a $14.4 TRILLION industry. You can't travel back in time, but you can set up your future. Click here for the whole story in our eye-opening report.

 

Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends CVS Caremark. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers