Chances are, if you're reading this article, you are aiming to be a successful long-term investor. And if you want to do well at investing, there are arguably two things you should do. First, pick an investing strategy you can execute through thick and thin. And second, find a role model you can emulate.
As a dividend growth investor, I am most focused on selecting great businesses with dependable profits. And this is largely the same strategy as the chairman and CEO of Berkshire Hathaway, Warren Buffett.
With a stake in the healthcare products distributor known as McKesson (MCK 1.16%) valued at $1.2 billion, the Oracle of Omaha seems to be impressed with the stock. But should you buy it for your portfolio? Let's take a closer look at McKesson's fundamentals and valuation to address this question.
Third-quarter results were decent
Since its founding in 1833, McKesson has grown to become the largest pharmaceutical and medical supplies distributor in the world. The company's $54 billion market capitalization is slightly more than the market cap of the next two largest competitors combined. This tremendous size and scale is important because it allows McKesson greater leverage with both its expenses and bargaining power with its customers.
As a result, the company's non-GAAP (adjusted) net margin is the highest in its industry among major competitors. In its last fiscal year ended March 31, the company's adjusted net margin was 1.4%. For context, this was 40 basis points higher than AmerisourceBergen's 1% adjusted net margin in its fiscal year ended Sept. 30. This may not seem like much of a difference. But with $200 billion-plus in annual revenue like these businesses, even the most modest difference in margins makes a huge difference in terms of profits.
McKesson recently shared earnings results for the second quarter ended Sept. 30. The company generated $70.2 billion in revenue during the quarter, which was equivalent to a 5.4% year-over-year growth rate. This respectable top-line growth was due to increased specialty product volumes in the U.S. pharmaceutical segment and market growth, but partially offset by the company's upcoming divestiture of its European business.
Shifting gears to the bottom line, McKesson's adjusted diluted earnings per share (EPS) fell 1.5% over the year-ago period to $6.06 in the quarter. Stemming from supply chain disruptions, the company's adjusted net margin decreased nearly 20 basis points year over year to 1.2%. This wasn't fully offset by a 7.5% reduction in McKesson's share count for the quarter, which explains how the company's adjusted diluted EPS growth lagged behind revenue growth during the quarter.
As the need for medical supplies and pharmaceuticals grows over time, the demand for McKesson's distribution services will also increase. This is why analysts believe that the company's adjusted diluted EPS will compound at 10.5% annually over the next five years.
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A dividend with tremendous upside
Given that the S&P 500 index offers investors a 1.6% dividend yield, McKesson's 0.6% yield won't be especially appealing to fully income-oriented investors. But the company's significant earnings growth along with a very manageable dividend obligation should translate into market-crushing dividend growth in the future.
It is anticipated that McKesson's dividend payout ratio will be just over 8% for its current fiscal year set to end next March. This is an appealing payout ratio for a variety of reasons. First, it provides the company with a huge cushion to maintain its dividend in the event of a temporary downturn in its financial prospects. Second, it gives McKesson the ability to invest in future growth opportunities and repurchase shares to fuel adjusted diluted EPS growth. Third and finally, the company has the means to hand out generous dividend hikes moving forward. This could lead to faster dividend growth than earnings growth for the next few years.
The stock is a reasonable value
In a down market, shares of McKesson have rocketed 55% higher year to date. While this would lead most investors to believe that they have missed the boat on the stock, McKesson could have plenty of outperformance left in its tank.
The stock's forward price-to-earnings ratio of 15.5 is moderately above the S&P 500 healthcare distributors industry average of 13.9. But this is a fair valuation considering McKesson's superior scale and profit margins compared to its competitors.
