CVS Caremark Corporation (CVS), Walgreen Company (WAG): Want to Benefit From Healthcare Expansion? Buy These Pharmacy Stocks

Steady EPS growth ($2.57 for 2011 grew to $3.03 in 2012; Q1 of 2013 clocked in at $.77 compared to $.59 for Q1 of 2012) and a reasonable P/E (17.7 on trailing twelve months earnings; forward P/E is 12.5 according to Morningstar) make this an attractive stock. The small cash dividend is sustainable based on a low payout ratio and should have plenty of room to grow.

Red flags

CVS Caremark Corporation (NYSE:CVS) suffered a sanction from the Centers for Medicare and Medicaid Services (CMS) for its SilverScript Plan in January, which means no new member enrollment until the sanction is lifted. Watch this relationship the long-term; as the administrator of Medicare and Medicaid, CMS is the 800-pound gorilla of healthcare, so hopefully CVS will get the sanction lifted soon and will avoid re-offending.

Walgreen

Due to a dispute with Express Scripts that has since been resolved (but not after doing some significant damage to earnings), Walgreen reported lower earnings per share (EPS) for FY 2012 than FY 2011 ($2.42 compared to $2.92).

Walgreen Company (NYSE:WAG) operates on a fiscal year; Q3 of FY 2013 is closest to Q1 of calendar year 2013. Walgreen reported a Q3 2013 EPS of $.65, up slightly from $.62 in the year-ago quarter, which was itself a decline from $.65 in 2011. Flat earnings two years running makes me wonder about Walgreen’s ability to capitalize on future growth opportunities.

Walgreen also recently settled a Drug Enforcement Agency investigation into its painkiller dispensing practices. While Walgreen may be able to benefit from CVS Caremark’s CMS sanction, the company is also having trouble with the government. Also, despite flat earnings and the other aforementioned issues, Walgreen trades at a P/E of 20 and a forward P/E of 13.0 (the forward P/E is the highest of the three pharmacy stocks). The stock is too expensive to be a value stock, and I don’t see the earnings growth to justify classification as a growth stock.

The Foolish bottom line

Buy CVS as a safe stock with great long-term growth potential. Buy Rite Aid if you like risks in return for outsized gains (that P/E ratio indicates huge upside potential, especially given the steady increase in earnings). Avoid Walgreen for the flat earnings and the Express Scripts and DEA missteps. I lean more toward CVS due to its established spot as a leader (and with a dividend), but that is my investment preference speaking.

The article Want to Benefit From Healthcare Expansion? Buy These Pharmacy Stocks originally appeared on Fool.com and is written by Michael Douglass.

Michael Douglass has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Michael is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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