McKesson (MCK 0.64%) isn't an obvious pick for most investors. It doesn't seem to grow very fast, and there aren't any clear catalysts for it to do so in the future. Still, investors like Warren Buffett probably aren't wrong about the stock's merits.
Let's see one argument in favor of the bears, and one from the bulls about why the stock is worthwhile so that you can judge for yourself if it might be a smart buy for your portfolio.
The bears have quite a few nits to pick with this stock
The bear thesis against buying McKesson stock isn't a unified narrative about why the company is going to fail, but rather that there is a collection of issues that make the stock less desirable to buy than others.
The first and most pressing complaint is that the business is inherently slow to grow. For example, in the third quarter of its 2023 fiscal year, revenue only rose by 3% year over year, reaching $70.4 billion. And its quarterly net income actually fell by 11% in the same period, dropping to a loss of $41 million. Given that it's very unlikely there will be a sudden burst of demand that'll fuel a gold rush for the company's medical supply distribution services, anyone who buys the stock needs to be comfortable with a leisurely pace of expansion. And that clashes with the idea of investing to outperform the market.
Another major element of the bear thesis is that McKesson's profit margin of 1.1% is so thin that practically any kind of disruption to its operations would drive it into negative territory, and the bears aren't wrong. Within its business model of buying medical supplies for cheap and selling them to its customers for slightly more, there simply isn't much wiggle room as competitors can easily undercut it if it tries to mark up its goods. Look at this chart:
MCK Profit Margin data by YCharts
As shown above, since 2013 its profit margin hasn't ever threatened rising past 2%, and brief dips into the red are relatively common. That undermines the concept of McKesson as a stock that's going to consistently compound in value over the long term since new competitors don't need to be significantly more efficient to have margins that are double or triple as wide. Earning $3 on $100 in expenses instead of $1 would be enough to make the stock of other players look a lot more appealing to investors, too, which would be a headwind for shareholders.
Finally, bears are quick to point out that the bones of McKesson's business are easy to mimic. Any other distributor can forge relationships with medical supply manufacturers and pharmaceutical companies to distribute their products to clinics. And any other distributor can build networks of customers, too. So eventually, they probably will, and then McKesson will need to get into a capital-intensive competitive fight with them, which could destroy its narrow margin for good.
History shows the bulls are right, and will likely continue to be
The bears are missing several key things when they argue the above, starting with the fact that McKesson doesn't need to be very innovative at all to keep doing what it's doing.
It currently has around 275,000 customers and upward of 285,000 products for its medical and surgical goods distribution segment alone. Its prescription technology segment serves more than 50,000 pharmacies. And it has more than 75,000 employees worldwide. So it has a gargantuan number of ongoing customer relationships, a mind-boggling number of products that it sells to those customers, and an army of people to connect resources to demand to generate profit.
As customers have the need for new products, McKesson is their obvious first point of contact. The company doesn't even need to develop new items to sell or secure new customers for growth, because it's a middleman. As long as the healthcare sector continues to grow, and it will, it can continue to operate its distribution networks and grow, too.
Furthermore, while it's true that it can only capture a small slice of the underlying sector's growth, that doesn't exactly matter in the long run so long as the growth is consistent -- and it is.
Over the last 20 years, the business increased its annual revenue by an average of 8.9% per year. It was narrowly profitable for most of that time, and while its diluted annual earnings per share (EPS) only rose by 29.3% over the last 10 years, the total return of its shares climbed by 275%, smashing the market's return of only 217%.
So even if McKesson looks like a laggard from the one-quarter view of its merit as an investment, it's a high performer upon zooming out. And even if the bears are right that some elements of its business model are easy to emulate, they miss the fact that the company's competitive ability is based on the strength of the relationships it has with customers and suppliers.
Since that strength carried the stock to victory in recent history and there's no indication that management has any plans to pivot, it's reasonable to expect it to continue in the future, and that's why the bull thesis is more compelling.
