CVS (NYSE:CVS) is worth a look right now. The company has made numerous strategic moves to position for the future, including acquisitions of a pharmacy benefits manager and large insurance provider. Assuming these investments yield results, the company has created a path for future earnings growth and long-term success for the price of CVS stock.
At $74 per share, this stock is a buy with upside potential. Here’s a closer look at why.
CVS Is Well Positioned in the Healthcare Space
A major race in healthcare is to produce better health outcomes at a lower price. This is a very welcome change to a public weary of outrageous healthcare costs with no clear results. CVS seems well-positioned to manage health outcomes through its new Healthhub concepts.
A hub concept ultimately creates shareholder value because hubs allow CVS a convenient way for patrons to check their health conditions.
If successful, integrating these services will drive future CVS earnings growth across numerous company revenue centers.
CVS Stock Could See 25% Upside
With a recent closing price around $74, what might increase the value of CVS shares over the next 12-18 months? As always, a look at the company’s own history guides valuation and highlights potential future opportunities.
Looking at the past decade, on average CVS shares sold for 13.8X earnings. Over that 10-year span, it was typically a good time to buy when price-to-earnings ratios were in high single digits and it was time to consider selling when P/E’s reached 13X to 15X.
Today CVS shares are available for 10X earnings.
If we assume CVS returns to normal historical profitability and a normal multiple of even 13X, then 25% upside or more over the coming year or so is reasonable.
How to Profit On CVS
When looking at CVS stock an investor might consider two approaches.
First, an investor could consider buying shares of this relatively stable stock and wait patiently for the price to return to normal valuation levels. A well-covered 2.69% dividend makes patience pay.
Second, an options-minded investor could consider a variant of a short straddle.
Using a margin account and standing ready to potentially buy additional shares in the future (if necessary) can sweeten returns even further by selling out-of-the-money covered calls and out-of-the-money naked puts. Here’s an example (using market prices from April 1).
This Real-Life Trade Offsets Risk
Buy 100 shares of CVS stock at $74.30 for a total cash expense of $7,430. Sell a Jan 23 $80 Call at $6.72 per share and immediately receive $672 cash premium. Then sell a Jan 23 Put at a $70 strike price and immediately receive $9.50 per share or $950 per 100-share contract.
In this example, the cash outflow to buy $7,430 worth of shares is $5,808. There are now three possible outcomes.
First, at expiration in January 2023, the price of CVS stock might be $80 or above. If that happens, your original 100 shares will be called away for $8,000. You will have 0 shares and your net profit on cash expended will be $2,192. That is a hefty 43% annualized return on investment.
Another possible outcome is that the share price at expiration is less than $70. If that happens, you will be forced to buy another 100 shares for $7,000. Your final position would be 200 shares of CVS stock with total cash expended of $12,808. The net average cost of those shares would be $64.04. A nice discount from the $74 share price at the trade’s inception.
The last possible outcome is that the stock price might close at expiration between $70 and $80. If that occurs, puts and calls expire worthless and the option seller keeps the premium.
CVS has spent the past several years positioning for a bright future via the acquisition of a pharmacy benefit manager and health insurance provider. Assuming these strategies come together to materially impact healthcare outcomes and expenses, the company is positioned for future earnings growth. This company is investable right now for patient investors willing to see results in the future and collect a dividend.
Options skills can help an investor hedge a bet on this company. Buying shares outright and selling covered calls and naked puts (a commitment to buy more shares in the future) can help reduce cash outlay and juice returns over the coming months.
As of this writing, Doug Morse did not have (either directly or indirectly) any positions in the securities mentioned in this article.
View more information: https://investorplace.com/2021/04/why-cvs-stock-has-room-for-25-upside-or-more/