CVS Caremark: Discounted Earnings Model Shows Fair Value Range

| About: CVS Health (CVS)

CVS Caremark Corporation (CVS), founded in 1892, is a leading pharmacy healthcare provider in the United States. Woonsocket, Rhode Island-based company operates in three segments: Pharmacy services segment, retail pharmacy segment, and corporate. The company manages 1 billion prescriptions per year with operating more than 500 retail health clinics and more than 7,000 retail pharmacies.

As of Sep 3rd, CVS Caremark stock was trading at $35 with a 52-week range of $27.96 – $39.50. It has a market cap of $47.2 billion. Trailing twelve month P/E ratio is 14.4, and forward P/E ratio is 11.1. P/B, P/S, and P/CF ratios stand at 1.2, 0.5, and 7.8, respectively. The 3-year annualized revenue and EPS growth stand at 8.1% and 9.2%, respectively. Operating margin is 6%, and net profit margin is 3.3%. The company has a low debt-to-equity ratio of 0.3. CVS Caremark has a yield of 1.3% for its shareholders

CVS Caremark has a 3-star rating from Morningstar. While its trailing P/E ratio is 14.4, it has a 5-year average P/E ratio of 15.8. Out of 24 analysts covering the company, 18 have buy, 2 have outperform, and 4 have hold ratings. Wall Street has diverse opinions on CVS Caremark’s future. The bottom line is 11.2% growth, whereas the top-line growth estimate is 17.8% for the next year. Average five-year annualized growth forecast estimate is 12.8%.

What is the fair value of CVS Caremark given the forecast estimates? In this article, the 23rd in the series, I will show a step-by-step calculation of CVS Caremark’s fair value using discounted earnings plus equity model.

Discounted Earnings Plus Equity Model

This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:

V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value

V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]

The earnings after the last period act as a perpetuity that creates regular earnings:

Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r

While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.

CVS Caremark’s Valuation

Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. Since we are in the middle of the year, it will be more feasible to take the average of ttm EPS of $2.47 along with the mean estimate of $3.17 for the next year.

E0 = EPS = ($2.47 + $3.17) / 2 = $2.82

Wall Street holds diversified opinions on CVS Caremark’s future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 12.8%. Book value per share is $28.41.

The rest is as follows:

Fair Value Estimator





E0 (1+g)/(1+r)




















Fair Value Range

Lower Boundary


Upper Boundary




I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5 year discounted-earnings-plus-book-value model, the fair-value range for CVS Caremark is between $45.40 and $73.81 per share.

As of Sep 3 close, CVS Caremark was trading at a price of $35, indicating that the stock is clearly undervalued. The stock is trading almost 30% lower than the lower boundary of its fair-value range. The market does not seem to appreciate CVS Caremark’s growth potential. The stock has 110.9% upside potential based on 12.8% annualized EPS growth estimate.

O – Metrix Confirmation

If the math above looks too complicated for you, try estimating the fair value using the O-Metrix as such:

O-Metrix = [(Dividend Yield + Growth Estimate) / (P/E Ratio)] * 5

  • Dividend Yield: Higher is better.
  • EPS Growth: Higher is better.
  • P/E Ratio: Lower is better.

The back-testing of this valuation technique on 40 large-caps shows that O-Metrix works very well over the long-term, such as five years. I am also continuously checking on specific sectors, and the formula works very well so far.

What is the O-Metrix Score?

  • CVS Caremark has a yield of 1.3%. Therefore, the yield is 1.3.
  • Growth estimate is the same as the discounted earnings model and is equal to 12.8%.
  • Since we are at the middle of the year, taking the average of ttm (14.4) and forward (11.1) P/E ratios will smooth the results. Thus, the average P/E ratio to be used in the model is 12.75.

O-Metrix = [(12.8 + 1.3) / (12.75)] * 5 = 5.53

Depending on the benchmark chosen, the market has an O-Metrix score range between 4 and 5. CVS Caremark's O-Metrix score of 5.53 is in the fair-value range. Back-testing of this ranking system shows that companies with higher-than-average O-Metrix scores beat the market with lower volatility. At a price of $35, the company is trading within the upper end of C-Grade, average-return zone.

[Click to enlarge]


CVS Caremark’s average P/E ratio in the last 5 years was 15.8. However, it is trading with a lower P/E ratio of 14.4, and forward P/E ratio of 11.1. With a profit margin of 3.34%, CVS Caremark offered 1.3% dividend yield last year. In the last 5 years annualized EPS growth was 11.51%. With a market cap of $47.2 billion, I expect the growth to keep its pace.

As of Sep 3rd, CVS Caremark was trading at $35, lower than my fair-value range of $45.40 and $73.81. Its price to book ratio of 1.2 is below the industrial average. The stock has a total debt/equity ratio of 0.3 and Beta of 0.78. SMA50 is -0.68%, whereas SMA20 is 4.65%. Analysts average target price of $42.47 is close to the lower-end of my fair value estimate. The stock has 110.9% upside potential based on 12.8% EPS growth estimate. I would prefer this stock. It pays substantial dividends and priced with a low P/E ratio. I think the current price offers a suitable entry point. You can download FED+ Fair Value Estimator, here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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