Dividend Growth Analysis
Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
CVS’s Dividend Growth Score is 97, indicating that dividend investors can likely expect many more years of higher and sustainable payout growth. As seen below, CVS has increased its dividend by 25% per year over the last 10 years and by 29.1% annually over the last three years.
Source: Simply Safe Dividends
Since spinning off from Melville Corporation in 1997, the modern CVS has never cut its dividend. In fact, it has one of the most impressive dividend growth track records of any dividend growth stock, with 13 consecutive years of payout increases that are likely to continue for a long time.
That’s because, as CVS’s sales, earnings, and cash flow grow, management is able to gradually increase the payout ratios over time, without sacrificing capital needed to continue investing into the business. For example, excluding acquisition related integration costs, the EPS payout ratio was 31% in CVS’s most recent quarter.
Management is guiding for that to grow to 35% by 2018, and given the impressive rate at which EPS and FCF have been, and are likely to continue to grow, this means that dividend investors can probably expect around 13% or so annual dividend growth over the coming years. That’s thanks to management’s long-term guidance (which it has a history of meeting or exceeding), or about 12% adjusted EPS growth, and low payout ratios with plenty of room to expand. I wouldn’t be surprised if CVS goes on to become a Dividend Aristocrat one day.
Valuation
CVS is down 25% since the start of the year and hit a 52-week low this morning after reporting earnings. Even after lowering guidance for next year, CVS’s stock trades for just 12.5x forward earnings guidance – a 21% discount to the S&P 500’s forward P/E multiple of approximately 15.9.
CVS also offers a 2.3% dividend yield, which is much higher than the stock’s five-year average yield of 1.4%. CVS’s dividend yield is also likely to take a major jump (e.g. 15-20%+) because historically management raises the dividend each December.
If CVS hikes the payout for 2017 by 20%, which would be in line with its historic dividend growth rate, then CVS will be offering a better-than-market yield of 2.8%.
At first glance, CVS’s valuation looks appealing; especially for a company that has 21.5% annual free cash flow per share growth over the last five years.
Indeed, if CVS can deliver double-digit earnings growth annually over the next few years as management and analysts expect, the stock appears to be a bargain with potential to deliver 10%+ annual returns over the next 5-10 years.
At the end of the day, given CVS’s relatively low P/E multiple and relatively high yield compared to history, a decision to buy the company is essentially all a bet on how confident one is in the company’s growth prospects. If you believe management’s earnings growth expectations and truly understand how CVS makes money (especially its PBM operations), the stock looks cheap.
If you are more skeptical about growth in light of the changing healthcare landscape, it might still be best to stay away.
