Shares of CVS Health (CVS -0.62%) leaped higher following an encouraging third-quarter earnings report. Signs of endurance through the COVID-19 pandemic inspired a lot of new investors to pile into this dividend-paying healthcare stock.
Here's why investors can expect market-beating returns from CVS Health for decades to come.
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1. CVS Health stock is cheap
Some unusual challenges drove adjusted earnings 9.8% lower year over year during the third quarter. While growth in 2020 might not be as impressive as in previous years, the market is treating this company as if growth is stalling. At recent prices, you can scoop up shares of CVS Health for just 8.8 times the midpoint of the company's adjusted earnings estimate for 2020.
At this multiple, you could probably earn a market-beating return if the company's bottom line stagnated into eternity, but steady growth in the high single digits or better seems far more likely. Despite all the challenges the COVID-19 pandemic has heaped on CVS Health in 2020, the company expects to finish the year with adjusted earnings 4% to 5% higher than in 2019.
2. It's resilient
By integrating thousands of retail locations with pharmacy and medical benefits management services, CVS Health is positioned to earn profits for its shareholders regardless of what the economy throws at it.
Most investors are familiar with CVS Health's retail operation, but the front of store purchases that produce famously long receipts are responsible for just 7% of this healthcare conglomerate's total revenue right now. The COVID-19 pandemic pressured third-quarter front of store sales growth down to just 2.7% year over year, and that isn't the only challenge CVS Health has faced in 2020. Aetna, CVS Health's health benefits operation has been paying for lots of COVID-19 testing and waiving out-of-pocket costs for thousands of hospitalized COVID-19 patients.
To top it off, Medicare Part D plans that the company divested in order to please antitrust regulators overseeing the company's acquisition of Aetna, its health benefits operation, took a bite out of the company's income statement in 2020. Despite a myriad of challenges, net cash provided by the healthcare conglomerate's diverse operating activities during the first nine months of 2020 rose 20% to a whopping $12.3 billion.
Image source: Getty Images.
3. The dividend's going to pop
From 2008 through 2017, CVS Health raised its dividend payout an outstanding 733%, but the dividend has been frozen in place since early 2017 to help pay off debts incurred to take on Aetna's enormous health benefits operation. The company expects to resume raising its payout once the amount of debt on its balance sheet is less than three times earnings before interest taxes depreciation and amortization (EBITDA).
During the third quarter, CVS Health paid down $4.75 billion in debt putting the company on pace to reach its deleveraging target, and resume raising its quarterly payout in 2022 as previously forecast. The current payout works out to less than one-fifth of free cash flow generated by the company's operations over the past year, which means there will be plenty of room for rapid payout bumps. At the moment, CVS Health shares offer a 3.1% yield, but investors that hold the shares through 2025 will probably see the yield on their principal reach double digits.
Remember to ignore the chatter
The 3.1% dividend yield shares of CVS Health offer right now isn't exactly thrilling, but those payments are yours to keep even if this stock tumbles off a cliff. Remember this if fear of a White House and Congress united under the Democratic party leads to an irrational meltdown for healthcare stocks.
Whatever happens with regard to healthcare reform, there are over 100 million Americans with pharmacy benefits or medical benefits managed by CVS Health and it's the only big provider with thousands of integrated retail locations to serve its members. As we've seen since the Affordable Care Act became law in 2010, CVS Health has positioned itself to make money managing health benefits. It doesn't matter if those benefits are paid for by employers, individuals, or the government.
