Walgreen Is Terrific, After That CVS

NEW YORK ( F.A.S.T. Graphs) -- Anyone vaguely familiar with TheStreet.com knows co-founder Jim Cramer.

While browsing other sites, I happened upon an update of Jim Cramer's show "Mad Money" by SeekingAlpha.com editor Miriam Metzinger. The article I'm specifically referencing can be found here, but the show is also on TheStreet here. You can see the video here.

Here's the quote from the original article that caught my attention: "CVS is terrific. After that I like Walgreen."

While I would certainly agree with Cramer in that both are great companies, perhaps you noticed my slight turn of the phrase within the headline. I could describe my reasoning, but I believe that a picture tells a thousand words.

Thus, allow us to view Walgreen ( WAG) and CVS ( CVS) through the lens of the F.A.S.T. Graphs fundamental analyzer software tool:

In viewing the business results of WAG, one notices a nearly perfect record of increased earnings. Indeed, over the last 15 years Walgreen has been able to grow earnings by almost 13% a year. Aside from a hiccup in 2012, the business has been the essence of consistency. If we move to the Fundamental Underlying Numbers (FUN) Graphs, a quick check of revenue (sale) and common equity, otherwise known as book value, tells a parallel story.

Sales grew from about $15 billion just before the turn of the millennium to $71 billion in the last year, or at an annualized rate of 11.65%. Likewise, book value grew from just under $3 billion to just over $18 billion, or at a compound annual rate of 14.18% over the last decade and a half. Obviously, the future performance is paramount to consider in viewing Walgreen as a potential investment. But if management can demonstrate analogous results in the future then it appears to be a sensible place for further due diligence.

Allow us to now look at CVS with the same characteristics in mind.

Here we see effectively the same graph that was demonstrated by Walgreen. In fact, if one were to quickly glance at both charts I would imagine they could easily be confused -- each had a small earnings misstep of late but has otherwise exhibited model consistency. Moreover, the 12.7% annual operating earnings growth rate for CVS is effectively the same number as Walgreen's 12.8% mark.

Let's move on to a similar "In Millions" FUN graph for CVS.

Much in the same manner as Walgreen, CVS begins the 15-year period with a book value of just under $3 billion along with revenue of about $15 billion. WAG was able to grow these components to roughly $18 billion and $71 billion, or by annualized rates of 14.18% and 11.65% respectively. As seen above, CVS has done an even better job by growing book value to almost $38 billion and sales to $100 billion, or by annualized rates of 14.36% and 20.31% respectively.

Taken collectively, the business results of both companies have performed quite well, with some underlying metrics indicating that CVS may have the upper hand. Interestingly, despite the commonalities between the companies and CVS's edge, the market has often valued these companies somewhat incongruently. Below I have added price, dividends and a normal P/E line to the first Walgreen chart.

Notice that while the normal P/E ratio of 26.7 is a mathematically correct number, it hasn't done an especially great job of demonstrating a reasonable range of valuation based on earnings. In the early 2000s the market often priced Walgreen at a valuation greater than the blue line, while of late the market has valued Walgreen more in tandem with the orange line representing 15 times earnings. Further, if one were to run a six-year F.A.S.T. Graph for Walgreen you would find a normal P/E of 15.2. This number appears more prudent moving forward, but it is interesting to note the market's high historic valuation.

Moving on to the CVS graph with price, dividends and a normal P/E included demonstrates a similar story. While the 18.5 normal P/E is mathematically correct, it hasn't proven to be especially telling of late. Likewise, if one were to run a six-year F.A.S.T. Graph the normal P/E of CVS moves to 14.5. Thus a P/E around 15 appears to be within a sensible range moving forward for both companies. Interestingly, despite CVS's similar business results, the market had historically chosen to give Walgreen a healthy premium valuation.

Finally, I have included the estimated earnings and return calculator for Walgreen (above) and CVS (below). This is a calculator that uses analyst's estimates from Standard & Poor's Capital IQ as the default to forecast a rational range of return possibilities given the assumptions.

In this case the consensus view from 21 analysts indicates EPS of $3.12 and $3.55 in the next two years, an 11.9% five-year growth rate and a dividend that grows in line with earnings. Through the power of F.A.S.T. Graphs one is able to customize this calculator, but the 13.1% annualized five-year estimated total return appears to be a sensible starting point given the estimates. As a quick check, Zack's demonstrates a consensus view of a 12.1% 5-year growth rate.

Somewhat coincidentally, CVS has precisely the same 13.1%, five-year estimated total return as Walgreen given the consensus of 22 analysts reporting to Standard & Poor's Capital IQ. Once more, checking the estimated earnings growth rate at Zack's, and the estimates appear prudent.

So at the end of the day you have two quite similar companies, with very similar operating results, both trading at a P/E of 16.3 and both with a default five-year annualized estimated return of 13.1%. In other words, while both look like reasonable places for further due diligence, choosing between them appears to be a wash.

So why do I like Walgreen over CVS? At today's prices it's semantics, truthfully, but I happen to favor Walgreen's dividend history and yield over CVS. Walgreen has paid a dividend for over 80 years and increased this payout 38 consecutive years. While CVS has also shown a strong propensity to consistently reward shareholders via increased payouts, management has only increased the payout for the last 10 years.

In addition, Walgreen currently yields 2.5% while CVS's yield 1.5%. Now it is true that CVS has a lower payout ratio and thus could increase its payout at a quicker rate. However, given the same P/E and the idea that very similar businesses will eventually have similar prospects, the math works out such that the higher initial yield will provide more income.

Overall, both companies appear to be positioned to address the lingering need of prescriptions and health care for an ever-aging -- not to mention well represented -- baby boom generation.

At the time of publication the author was long WAG.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Charles (Chuck) C. Carnevale is the creator of FAST Graphs.

Chuck has over 43 years of financial experience and is the co-founder of the earnings and price correlated, powerful fundamentals analyzer software tool - FAST Graphs. Chuck holds a Bachelor of Science in Economics and Finance from the University of Tampa. Chuck's work stressing sound valuation has been widely published on numerous financial sites and blogs. Chuck is passionate about spreading the critical message of valuation and prudence in fundamental investing. So much so that regular readers have dubbed him "Mr. Valuation". Chuck is a Veteran of the Vietnam War and was awarded both the Bronze Star and the Vietnam Honor Medal.

Chuck believes that correctly assessing fair value is one of the primary keys of successful stock investing, and he has dedicated his more than 40 years of experience in finance to its pursuit. Chuck agrees with legendary investors such as Warren Buffett, who recognize how important it is for investors in common stocks to possess an intelligent framework for making sound decisions that can keep emotions out of the equation. With making smart stock selections, there is no room for fear and greed.

Chuck was fortunate to learn at an early age that earnings drive long-term stock prices, and that dividends, if any, will be paid out of a company's earnings. This led him to develop FAST Graphs, the fundamentals analyzer software tool that reveals the long-term relationship between a company's earnings and its stock price and dividends over time. Chuck is most interested in the business behind the stock.

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