RealMoney Silver - Express Scripts Looks Poised for Further Gains

Express Scripts Looks Poised for Further Gains
By John Reese
RealMoney.com Contributor
5/20/2008 12:59 PM EDT

A number of factors were behind the expansion in pharmaceutical benefits for seniors that was signed into law a few years ago: an aging population; an increasing number of effective drugs and the cost savings associated with treatment before diseases reach an advanced stage.

Pharmacy benefit managers, or PBMs, which dispense drugs for insurance companies, HMOs and others, are a key beneficiary of that legislation. PBMs also influence what drugs are purchased, identifying generic replacements whenever appropriate.

PBMs are in a sizable business. You have probably interacted with a PBM if you have ordered prescription drugs online or on the telephone. Express Scripts (ESRX) is the third-largest PBM in the country, processing 420 million prescriptions in 2007. It serves about 55 million customers that come to it via employers, managed care plans, governments and labor unions.

Morningstar notes that Express Scripts has been quite profitable, boosting profits 23% annually over the last five years. Morningstar believes that profit growth will slow to 6% in coming years. Yet because of share repurchases, EPS growth should approach 12.5% annually.

Run It Past the Gurus

My technique for finding stocks worth buying is to take the strategies used by several of Wall Street's best, automate them to allow the nearly instantaneous analysis of thousands of stocks, and then to pick those stocks favored by any of the strategies.

Express Scripts is favored by the investing strategies deployed by William O'Neil and William O'Shaughnessy. O'Neil is the publisher of Investor's Business Daily and is a highly respected investment strategist, while O'Shaughnessy is a well-known author and mutual fund manager.

Rather than looking for stocks that are cheap, as many strategies do, the O'Neil strategy looks for stocks that relatively high priced but poised to break out and do even better. The thinking here is that if you want to buy a quality stock, you have to pay for it. Buying stocks on the cheap, just like buying most things on the cheap, will usually not get you quality.

For this reason, the strategy looks for stocks that are trading within 15% of their 52-week high. Right now, Express Scripts' stock is within 9% of its 52-week high. The strategy looks for EPS growth in the current quarter to be at least 18% higher than for the same quarter a year earlier. Express Scripts' current quarterly EPS is 45.8% higher than it was a year ago.

Annual earnings growth needs to be north of 18% and preferably more than 25%. Express Scripts' annual earnings growth over the past five years has been 29%.

Another plus is the consistency of EPS growth. For each of the past five years, EPS has increased. Relative strength is a way of looking at how well a stock has performed during the past year in comparison with the overall market as measured by the S&P 500. A relative strength of, say, 80, means the stock has outperformed 80% of all S&P 500 stocks. The O'Neil strategy wants relative strength to be at least 80 and preferably 90 or more. Express Scripts' relative strength was a seemingly drug-enhanced 93.

The O'Neil strategy is unusual in that it also looks at the desirability of a company's industry. It measures an industry's attractiveness by requiring at least one other company in the industry to have a relative strength above 80. Express Scripts' industry, retail drugs, has six such companies.

Another plus is the company's return on equity. The strategy requires ROE to be at least 17%; Express Scripts' ROE is 62.6%.

O'Shaughnessy Says

The strategy I use that's based on O'Shaughnessy's writings requires a company to have a market cap of at least $150 million; Express Scripts' market cap is a towering $17.8 billion. This strategy, like the O'Neil strategy, requires EPS to be consistently increasing. Further, the strategy looks at the price-to-sale ratio, which should be 1.5:1 or less. Express Scripts' is 0.97.

Also like the O'Neil strategy, the O'Shaughnessy strategy factors in relative strength. It requires that the company's relative strength be among the top 50 of the stocks screened using the previous criterion. Express Scripts' relative strength of 93 is in the top 50.

It is true that Express Scripts sells a commodity service and competes for clients largely on price. This makes the PBM business a competitive and tough one. But Express Scripts is one of the largest in its industry, and it has a solid reputation and a history of solid performance. Demand for services offered by Express Scripts is likely to remain strong, and the O'Neil and O'Shaughnessy strategies suggest that its stock should be a winner for some time to come.