CVS Health Corp.: Prescription For Dividends

| About: CVS Health (CVS)

Summary

Dividend growth is an important part of our dividend strategy.

CVS Health Corp offers impressive dividend growth.

Is CVS trading at an attractive valuation?

I am a dividend growth investor. I want to own shares of companies that reward shareholders with dividends and dividend growth. When I first started investing, I was focused almost entirely on yield, as I thought larger yields was the most important thing to reach my retirement goal of living of dividends in my golden years. I loaded up on the Altrias (NYSE:MO), Realty Incomes (NYSE:O) and AT&Ts (NYSE:T) of the world. If a company didn't offer a starting yield above 3%, I wasn't interested. These types of stocks offered a great starting yield but often didn't provide much in the way of high dividend growth. While those positions have been fairly successful, I began to wonder if I was missing out on quality companies simply because they offered lower yields.

As my investment philosophy has "matured" over the years, I've come to realize that dividend growth is an important aspect of dividend growth investing. Companies that are able to aggressively raise their dividends usually do so because earnings are accelerating and they are able to offer investors an excellent reason to own their stocks. Since I've decided to expand my investing universe into lower yielding/higher dividend growth stocks, I've added companies like Visa (NYSE:V) and Starbucks (NASDAQ:SBUX). These companies often had yields below 1 or 2%, but can offer great dividend growth. Visa has raised its dividend an average of 30.7% the last five years, while Starbucks has done so to the tune of 30.5% per year over the same time period. How many companies can claim a dividend raise of over 30% every year for the past 5 years?

Focusing on quality companies that offer hearty dividend raises brought me to CVS Health Corp (NYSE:CVS). One of the largest pharmacy benefit managers and drug store chains in the country, CVS operates almost 10,000 retail drugstores in the United States, Puerto Rico and Brazil. According to S&P Capital IQ, the company was responsible for filling almost 22% of the country's prescriptions in 2015. CVS purchased Target's (NYSE:TGT) pharmacy in December 2015. This purchase added more than 1600 pharmacy locations and 80 store clinics, increasing their foot print even more. As people age, the likelihood of needing medicines to fight infections and disease increases. Combine this with expansion of medical insurance coverage under the Affordable Care Act and CVS is in the sweet spot for pharmacy benefit managers.

When it comes to dividends, CVS's track record has been rock solid. According to David Fish's U.S. Dividend Champions, CVS has raised dividends 13 consecutive years. Not nearly the track record of some Dividend Aristocrats, but this is an impressive growth streak that shows the company is serious about rewarding shareholders with annual raises. As of 7/12/2016, the company's dividend yield is 1.76%. In my early days of investing, I would have deemed this yield too low to be attractive to purchase. I would've missed out on some impressive dividend growth though. The 3, 5 and 10-year dividend growth rates are 29.1%, 32% and 25.4% respectively. There aren't too many places you can get a raise of this magnitude from a company that is dominate in their sector of the economy.

As a dividend growth investor, the dividend streak and growth rate have me very interested in purchasing more shares of the company. All of this can be a moot point if the stock is trading at an unattractive valuation. On 6/2/2016, I had an article published that detailed a shopping list of stocks I was hoping to purchase. If you'd like to read that article, click here. The company was first purchased for my wife and I's portfolio at $99.40 on 12/282/2015. I've been looking to add to our CVS position for a while. Because the company has raised dividends for at least 10 consecutive years, I consider CVS to be a Supporting Position in our portfolio. To qualify for purchase, I have the following rules for buying shares in a Supporting Position:

Have 5 years of dividend growth or 10 years of paying uninterrupted dividends. Are considered by S&P Capital/Morningstar to be at least fair valued. Are considered by F.A.S.T. Graphs to have a current price to earnings ratio no more than 5% overvalued when compared to the five-year average price to earnings ratio. Have a dividend yield above 1.0%

At the time of the article, CVS was trading at $96.45. These were the fair values and price targets for the company at that time:

Current Yield

# Years div growth

5 Year Div Growth Rate

1.75%

13

32%

S&P Capital 12-month price target

S&P Capital Fair Value

Morningstar Fair Value

$119

$111.90

$104

F.A.S.T Graphs Current PE

F.A.S.T Graphs 5 Year Avg PE

Price Target

17.9

16.5

Under $116

Click to enlarge

CVS was undervalued by every metric I use except for F.A.S.T. Graphs' PE ratio. I am willing to pay up 5% over fair value for a company with at least a decade of dividend growth. While the PE ratio was a little more than the 5% premium I am normally willing to pay, the company was undervalued by every other metric that I use. That made pulling the trigger on batch of shares a lot easier to make. On 7/7/2016, we purchased shares at $96.55. CVS now represents about 2.31% of our total portfolio. I consider a positions to be full when it makes up 5% of the portfolio, so there is room to make future purchases of CVS. What are your thoughts on our purchase? What stocks are on your watch list?

Disclosure: I am/we are long CVS, V, O, T, TGT, MO, SBUX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We are not investing professional. Please do your own research prior to making an investing decision.