Even if you've never heard of McKesson, (MCK 0.08%) you've almost certainly experienced the benefits of the healthcare supplies it distributes. But this company does far more than move goods from one place to another; it gives the healthcare system the raw materials it needs to facilitate good health outcomes.
And that means it has the potential to be a relatively safe investment over the long term. Before you take the dive and buy shares, however, it pays to know a few critical things about this business that smart investors are already aware of, so let's check them out.
1. Scale is its strength
McKesson is perhaps the single most important supplier of medical goods and pharmaceuticals in the U.S., bringing in $263.9 billion in sales for 2022. At the same time, its profit margin of 1.1% is incredibly narrow, so maintaining a massive scale is necessary to generate significant amounts of capital to return to investors. And smart investors appreciate that the company's scale confers a few powerful advantages that serve to protect its market share from its competitors, especially against any new entrants to its markets.
First, it can negotiate with manufacturers to make bulk purchases of goods that drive its per-unit costs down enormously. It has multi-year relationships with more than 500 manufacturers of branded drugs, which is nothing to sneeze at in a competitive world.
Second, it offers so many different products that its existing customers can buy almost everything they might need without looking for another supplier. Its catalog of non-drug medical and surgical products features more than 300,000 items, and roughly 95% of its customers enjoy the benefit of next-day delivery of whatever they ordered. And because McKesson gets goods cheaper, it can pass on the low costs to its customers, who might not be able to find better deals elsewhere.
2. It's a Buffett stock, but not a favorite
Smart investors probably already know that Warren Buffett's Berkshire Hathaway holds a 2.1% stake in McKesson. Though the stock only accounts for 0.3% of Berkshire's portfolio, over the last 20 years its quarterly revenue grew at an average pace of 8.6% per year, which fits with the slow-and-steady-wins-the-race pattern that Buffett tends to appreciate. Likewise, its diluted quarterly earnings per share (EPS) grew by 596% over the last 10 years, and management is aiming to generate adjusted EPS growth of at least 10% per year for the long term. To Buffett, that pace is just fine, even if it might seem a bit slow for growth-oriented investors.
The other thing about McKesson that Buffett probably likes is that its valuation tends to be well-grounded. Its price-to-earnings (P/E) multiple is 17, which is cheaper than the average stock's ratio of 21.9. More importantly, its P/E has hardly changed whatsoever from what it was in 2013, which means that the market hasn't bid up its shares in the expectation of massive future growth. Of course, Buffett's wise bet on this stock is that it will actually experience massive future growth, just that it'll come one tortoise-step forward at a time. So far, he's right.
3. Its stock has a habit of outperforming the market -- somehow
If you bought shares of McKesson at any point in the last 10 years, the total return of your shares would be better than if you had invested in an index fund. Since April of 2013, the total return of its shares has climbed by 275%, whereas the market has returned only around 217%.
It doesn't seem to make sense that a slowly expanding business in the totally uncool field of medical supply distribution could beat the market big time. Still, smart investors understand that the quietest and most boring companies are often better at compounding in value over the long term than flashier growth stocks that are apt to burn out or experience wild swings as the market's sentiment shifts.
The takeaway here is that Warren Buffett's approach to investing in this company is the correct one if you plan to nibble on a few shares. The economy and the market will fluctuate a lot from year to year, but over the next 10 to 20 years, it's hard to envision a future in which there isn't higher demand for medical supplies than there is today. And that means McKesson has a long and clear runway to expand and to gradually return some capital to its investors, even if its progress might look unremarkable from the perspective of any single year or quarter.
