When you combine 72 million aging baby boomers with the great prescription drug needs of the elderly, it results in massive pharmaceutical demand. The Kaiser Family Foundation reports that U.S. prescription drug spending was $234 billion in 2008. By 2019, it will swell to $457 billion. For investors like us, this means one thing… opportunity.
Want to make 12.5% for tying up your money for 31 days? If the market ends up accepting your low-ball offer, you will own one of the most profitable, shareholder-friendly pharmacies in the world.
Why We Love This Pharmacy - CVS Caremark (NYSE: CVS)
It's in the perfect position to benefit from aging boomers. That's because nearly 70% of CVS's revenue comes from its retail pharmacy business.
CVS's revenues, operating cash flow, net income, and earnings per share all have steadily increased in each of the last three years. In that time, revenues have jumped nearly 30%. Operating cash flow is up nearly 40%. And in its latest quarterly earnings report in May, earnings per share topped last year's result by 28%.
One thing boosting CVS's numbers involves a spat between Walgreen and Express Scripts (a pharmaceutical company that partnered with Walgreen). In June 2011, Walgreen and Express Scripts were at odds over payment issues.
They couldn't find a solution, so they parted ways. This killed a $5.3 billion relationship. It also left millions of people with Express Scripts drug plans without a pharmacy.
CVS CEO Larry Merlo went on the offensive. He ramped up marketing efforts to target disgruntled Walgreen consumers. It worked.
CVS reports it has gained about 3-4 cents in earnings per share from the customers taken from Walgreen. At first, some analysts discounted this. They believed as soon as Walgreen and Express Scripts agreed on a new deal (which has happened), those customers would return to Walgreen.
But in the May quarterly earnings conference call, Merlo said CVS has met its goal of 60% "Walgreen" customer retention. CVS is thriving. But what is it doing for shareholders?
In the last four years, CVS has increased its dividend 195%, from $0.0763 per share in 2009, to $0.23 per share today. And on September 9, 2012, its board authorized a new share buyback program of up to $6 billion worth of stock.
Share buybacks act like "secret" dividends. They reduce the number of shares in the market. This makes your shares more valuable.
$6 billion of buybacks is about 8% of CVS's entire market value. We're pleased to see so much profit returned to shareholders. Especially on top of 195% dividend growth. We have a great company that rewards shareholders. But is it a good value if the market accepts your offer?
Yes. Right now, CVS trades at a P/E ratio of 19. This is also the average P/E ratio for the New York Stock Exchange. That's the exchange on which CVS trades. This means it's fairly valued relative to all other NYSE stocks.
["P/E" stands for "price-to-earnings." A P/E ratio tells you how many years of earnings it would take to earn back the total value of your investment. Investors use this metric to determine how cheap or expensive a stock is. You calculate it by dividing the stock price by a company's earnings per share.]
When we look at the pharmacy market alone, it gets better. Walgreen is CVS's closest competitor. It has a P/E of over 21. This shows us we're getting a better relative deal with CVS. We find the same result looking at the two companies' price-to-sales ratios. These tell us how much we're paying for each dollar of revenues. CVS's ratio is 0.61. Walgreen's is 0.65. CVS is America's best pharmacy. Baby boomers have growing pharmacy needs. Now, let's go make 12.5% from this opportunity.
Action to take: Sell to Open the CVS Caremark August 2013 $57.50 put (CVS130817P00057500)
We've illustrated the annualized returns for three different limit prices below:
The eager limit price of $0.40
The eager limit price is if you want to make sure you execute this trade as soon as possible. You don't mind sacrificing a little of your annualized gain to just get the trade done. You're telling your broker the minimum you're willing to accept is $0.40. That's an annualized return of 8.2%.
The in-between limit price of $0.60
The in-between price is if you want a balance between the other two choices. You don't feel the need to get into the trade immediately. You like the trade, but you don't want to sacrifice too much of the annualized gain just to get a trade executed. You're telling your broker the minimum you're willing to accept is $0.60. That's an annualized return of 12.3%.
The strict limit price of $0.75
The strict limit price is if you don't mind passing up a chance to execute this trade today or the rest of this week. In fact, you could miss the trade altogether, but you want to make sure you get the highest-possible annualized return with your money. You're telling your broker the minimum you're willing to accept is $0.75. That's an annualized return of 15.4%.
[There are two order types, market and limit. If you enter a market order, you are telling your broker to fill the trade at the current market price, whatever it is. If you enter a limit order, you are giving your broker the minimum price you're willing to accept, even if it means you miss executing the trade or have to wait longer to get it filled.]
I recommend that you always check the current market price of the option before entering your trade. Then you can compare the current price of the option to the suggestions we've given you. The following are three different limit prices to illustrate the annualized returns, provide you with several choices, and give you more control in executing these trades.
To place this trade, you're going to tell the broker, "Sell one put option on CVS Caremark with a strike price of $57.50 expiring on August 16th."
You'll receive a minimum of $0.40, $0.60, or $0.75 per share for selling one put option. And since one put option represents 100 shares of stock, you'll get $40, $60, or $75 in cash (less any commissions charged by your broker).
The cash that you will be paid is coming from someone else. He or she is paying you to make a commitment to buy CVS Caremark from him at $57.50 per share, with a deadline that expires on August 16, 2013.
Plus, the cash you get is yours to keep. You get this cash right after you execute the trade.
The Potential Outcomes of This Trade
If we place this trade, one of two things can happen:
Either CVS Caremark's stock will be trading below $57.50 per share on August 16, 2013, in which case, we'll own the stock. You'll keep the money you earned from selling the put option. Your broker will debit your account to purchase 100 shares of CVS Caremark.
Or… CVS Caremark's stock will be trading above $57.50 on August 16, 2013, in which case, you won't own the stock. You can immediately make another offer on August 19, 2013, and try to purchase CVS Caremark again.
[Options expire on the third Friday of each month. That means August 16, 2013, is expiration day. The next trading day is August 19, 2013. That's the earliest we'd be able to sell another put option.]
In both cases, you'll keep the income you've earned.
How Many Option Contracts of CVS Caremark Should You Sell?
The number of option contracts you choose to sell is an individual decision. It depends on how big your portfolio is and how much CVS Caremark stock you're willing to own at $57.50 per share. This means one contract will require $5,750. As a general rule of thumb, you shouldn't tie up more than 20% of your capital in each trade.
The following chart shows the money you'll receive from today's recommended trade, based on the number of contracts you decide to sell versus the amount of capital you'll be required to set aside for selling these CVS Caremark options.