The Pharmacy Stock That's Cheaper Than It Should Be

Despite significant market volatility and looming economic troubles, it's been an excellent year for CVS Health (NYSE: CVS): Shares of the pharmacy giant have soared by 76% since early January. Despite this strong performance, an argument can be made that CVS remains more than reasonably valued. That's the case if we go by at least one popular valuation metric -- the stock was recently trading at 10.7 times forward earnings, much lower than the 17.3 average for the healthcare industry.

Digging deeper into CVS Health's business reveals an excellent outlook that makes it a strong buy, especially at current levels.

CVS Health's recent financial results

For the past few years, CVS has been dealing with problems in its Medicare Advantage (MA) unit, part of its healthcare benefits segment, which primarily provides a range of insurance-related services. The company was struggling to keep costs down and margins up, leading to worsening results on the bottom line. Last year, the MA segment's operating margins were in the range of negative 4.5% to negative 5%.

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The healthcare giant is still facing these problems, but recent financial results have been much better than anticipated, driving the stock up significantly. In the second quarter, revenue increased by 8.4% year over year to $98.9 billion, while adjusted earnings per share came in at $1.81, down slightly from the $1.83 reported in the year-ago period. Those may not look like excellent results, considering the company's struggles in recent years. But the market cheered its quarterly performance, especially since it blew past Wall Street's expectations.

Though its retail pharmacy segment was strong, CVS also owed that performance to several dynamics within its healthcare benefits unit, including increased revenue from government insurance programs compared to last year's Q2. In fairness, some of its improvements during the period were not exactly organic. The bottom line got a boost from changes to risk-adjustment estimates within the individual exchange business.

Even so, CVS Health's financial performance this year has been a welcome surprise for the company and the market.

Why the future is bright

CVS has a plan to deal with its MA-related woes. The company is scaling back these operations, choosing to boost earnings by focusing on improving margins rather than volume. In the long run, its prospects look attractive due to its significant footprint across the U.S., the relationship it has built with major players in the healthcare sector over the years, and the diversified mix of services it offers. Let's unpack that a little more.

The company serves about 185 million people, runs more than 9,000 retail pharmacies, and is, in fact, expanding its footprint as it acquires some of Rite Aid's former locations. Many people have been going to CVS stores for years and are accustomed to getting prescriptions there. The healthcare giant has adapted to modern demands by offering delivery options for prescriptions. Furthermore, through its retail stores, insurance unit, and pharmacy benefits manager (PBM) business, CVS Health supports patients through much of their care journeys.

Keeping them within its ecosystem is a win for both CVS and the people it serves. For patients, that's simpler and more efficient than dealing with a fragmented set of providers for different needs and demands. The company has expanded its reach within the healthcare system in recent years. In 2023, it launched Cordavis, which partners with other companies to produce and market cheaper biosimilar drugs. CVS Health has also expanded its network of primary care centers through acquisitions, such as that of Oak Street Health, which it bought in 2023 for about $10.6 billion.

CVS Health's significant reach in the sector and established partnerships will be major strengths as it benefits from increased healthcare spending, partly due to an aging population. The company's headwinds are real, but it's addressing them. Given its prospects, shares look highly attractive at current levels. Even as it's up 76% this year, CVS Health has plenty of upside left, especially for investors willing to hold on to its shares for a while.

Prosper Junior Bakiny has no position in any of the stocks mentioned. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.