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Ben Reynolds
Ben Reynolds
Articles (695)  | Author's Website |

My Favorite Stock in the S&P 500 Today

I expect this Dividend Aristocrat to generate annualized total returns of up to 21% a year over the next 5 years

July 07, 2018 | About:

The S&P 500 Index, as a whole, trades for an average price-earnings ratio of approximately 25.

This is a high multiiple relative to the S&P 500's historical average price-earnings ratio of 15.7. But there are still plenty of high-quality S&P 500 stocks trading at attractive valuations.

For example, S&P component Cardinal Health Inc. (NYSE:CAH) has seen its share price decline by 35% over the past year. The decline has occured in large part because of fear surrounding the opioid epidemic and the threat of a potential large player entering the pharmaceuitcal distribution industry.

While the steep decline has been frustrating for current shareholders, it has given prospective investors a compelling buying opportunity.

Cardinal Health still has a positive growth outlook. And now, thanks to its falling share price, it has a low valuation and high dividend yield, which is part of the reason why Cardinal Health is my favorite S&P 500 stock today.

Business overview

Cardinal Health is one of the "Big Three" pharmaceutical distributors in the U.S., along with McKesson Corp. (NYSE:MCK) and AmerisourceBergen Corp. (NYSE:ABC). The industry is largely controlled by just these three players.

The pharceutical distribution industry is characterized by low margins. Cardinal Health's net profit margin is only 1.3%, as an example. Low margins have, in the past, limited new entrants into this industry. It's simply too costly to build the scale that Cardinal Health and the other large pharmaceutical distributors have to reach profitability.

With that said, one notoriously low margin company has signaled it may be entering the market: Amazon.com Inc. (NASDAQ:AMZN).

The news that Amazon has acquired PillPack, an online pharmacy startup that packages and delivers pre-sorted doses of medications, has negatively impacted Cardinal Health's share price.

Investors should note that PillPack is an online pharmacy, not a pharmaceutical distributor. It is unlikely the acquisition has any material affect on Cardinal Health's business, aside from causing investors to panic sell and reduce its share price.

On May 3, Cardinal Health reported fiscal third-quarter financial results. Revenue increased 6% to $33.6 billion thanks to higher volumes. Adjusted earnings per share, however, decreased by 9% due, in large part, to an unexpectedly high tax rate from the company's Cordis segment.

Growth and valuation

Despite the pressure of Amazon as a potential new competitor, we still view Cardinal Health positively because it has an entrenched position in the pharmaceutical distribution industry.

Cardinal Health serves over 24,000 pharmacies and more than 85% of hospitals in the U.S. This kind of scale should allow the company to retain its competitive position, even with Amazon as an emerging threat.

We still believe Cardinal Health has growth potential because the U.S. is an aging society. The baby boomer generation is over 70 million strong, which will require higher levels of health care spending in the years ahead. Acquisitions will help drive future growth.

For example, Cardinal Health acquired the Patient Recovery business from Medtronic (NYSE:MDT) in 2017 for $6.1 billion to broaden the company’s product offerings. Management expects the acquisition to add 21 cents of earnings per share in 2018, and 55 cents in 2019.

Cardinal Health stock appears to be significantly undervalued with a price-earnings ratio of just 10.3 using expected 2018 earnings per share. We believe the stock should trade for a price-earnings ratio of 15.5, which is its historical average price-earnings ratio since 2010.

If Cardinal Health trades up to fair value, the valuation expansion could add 8.5% per year to annual returns. In addition, I expect Cardinal Health to grow earnings per share by 9% per year through 2023. When adding in the 3.8% dividend yield, I believe total returns could exceed 21% per year over the next five years.

Cardinal Health has a highly secure dividend payout. The company has increased its dividend for over 30 years in a row, which makes it a member of the Dividend Aristocrats. Moreover, the company is likely to have a dividend payout ratio less than 50% in 2018, which should allow it to continue increasing its dividend each year.

With a positive future growth outlook, an attractive valuation and a high dividend yield, Cardinal Health is my favorite stock in the S&P 500 today and a strong buy.

Disclosure: I am long CAH.

About the author:

Ben Reynolds
I run Sure Dividend, a website that finds high quality dividend stocks for long term investors using the 8 Rules of Dividend Investing.

Visit Ben Reynolds's Website


Rating: 4.2/5 (5 votes)

Voters:

Comments

sagrew
Sagrew premium member - 6 days ago

Ben, Thanks for the article. I agree. CAH very attractive right now.

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