Walgreens Is Offering A Fair Shake

| About: Walgreens Boots (WBA)
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There have been several instances in the last decade where shares of Walgreens turned out to be quite compelling.

Even when shares have not been as interesting valuation-wise, reasonable returns have still been had.

Although today’s valuation proposition may not be yelling out, shares of Walgreens could still very well be offering a “fair shake.”.

In the past decade there have been three distinctly compelling periods to buy shares of Walgreens (NASDAQ:WBA): during the 2008/2009 recession, for a period in 2010 and in the middle of 2012. The share price dipped into the $20s all three times; representing a valuation that was closer to 10 times earnings as compared to 20 for the long-standing dividend aristocrat.

Incidentally, I happened to partner with the company the last time shares dipped into the $20's in 2012 and later detailed the first-world investing problem of having to deal with a quick "two-bagger" or investment that doubled in value.

Granted at the time the investment certainly wasn't seen as a "sure thing." When the share price dropped from the mid-$40's to the high-$20's it came with a downbeat sentiment, specifically related to Walgreens' deal (or potential non-deal) with Express Scripts (NASDAQ:ESRX). Yet that's sort of par for a compelling valuation. Outside of an economy-wide recession, you don't often see material share price declines in light of an improving business.

If you could have stomached the short-term share price volatility and considered the long-term potential, each of those periods would have generated substantial returns today.

A $10,000 investment back in February of 2009 would now be worth $37,000 including dividends but prior to thinking about reinvestment. That's good for a total return on the magnitude of 19% per annum.

Had you invested $10,000 back in June of 2010, today that investment would be worth around $33,000 - good for an average compound annualized gain of over 21%.

Or a $10,000 investment in June of 2012 would now be worth $29,000 - equating to an annualized rate of return nearing 29%.

In each instance you would have seen exceptional returns by purchasing shares at very compelling valuations and hanging on. And those are the things that people like to fixate on.

However, none of that is exactly the point. Instead, I think that there is a very important counterpoint that results. Everyone likes to look back and see what the best of times looked like ("gee, if only I had bought Apple (NASDAQ:AAPL) in 2003") but far fewer people think about the absolute "worst" times to buy. In my view, these sorts of things can be just as instructive.

In looking over the last decade, perhaps the "worst" time to buy shares would have been in the middle of 2006. Note that I'm excluding the last couple of years, as the time horizon is not yet lengthy enough to be classified as "long-term" in my book.

I remember looking at Walgreens back in 2012 with a dividend yield approaching 3.8% and a P/E ratio near 10 and thinking, "the company doesn't have to do much to generate reasonable returns." Compare that to the middle of 2006.

The share price reached $50, nearly double what it would be a couple of years later and fully 60% higher than what the offering price would eventually be six years later. The dividend yield sat at an unimpressive 0.5% and the P/E ratio was approaching 30. Had I come to you in 2006 and told you this information, that the share price would crater in the years to come and the valuation, even today, would be greatly compressed, I'd argue that not many would have made that investment.

Yet here's the thing: luckily the investors of 2006 didn't have the "benefit" of cloudy foresight. Despite the much lower share prices to come, despite the low dividend yield and well above average P/E ratio an investment in 2006 still would have worked out alright. A $10,000 starting investment would now be worth about $18,000 prior to thinking about reinvestment; that's good for a 6% annualized rate of return.

Now certainly this pales in comparison to the possible returns that would be offered in the years to come. However, I believe that looking at the "worst" possible time to invest provides a good deal of clarity.

A 6% annualized rate of return isn't spectacular, but it is very much positive and wealth building. A lot of investors fixate on the best of returns, but even adequate gains (or in this case one of the lesser ones you could find over the last decade) can add to your bottom line nicely. The investing world is filled with many more positive opportunities than negative ones.

The second idea is that nothing prevents you from buying more shares when (or if) the share price does decline. Scores of investors get spooked or worry when the share price goes down, at the exact time when opportunity tends to be presenting itself.

So let's use that information to think about Walgreens today.

As I write this, shares of the company are trading hands around $80. The dividend sits at $0.375 per quarter or $1.50 on an annual basis. Adjusted earnings for this year are anticipated to be in the $4.25 to $4.55 range; call it $4.40. Under these circumstances shares currently carry a dividend yield near 1.9% and an anticipated P/E ratio of about 18.

As a point of reference, shares of Walgreens have traded with an average earnings multiple near 25 over the past two decades, closer to 19 during the last decade and closer to 16 or so in the last five years. So today's valuation is more or less reasonable in a historical sense, but it's certainly not at the "compelling" level that it has been in previous periods. Yet remember, this alone does not indicate that an investment thesis is lost.

Estimates for the company's growth rate over the intermediate-term are currently around 13% per annum. Let's scale that back a bit and call it say 7% instead. If your expectation is that Walgreens can grow earnings (and dividends) at this rate and trade at perhaps 17 times earnings, today's investor would come away with an anticipated annualized return of about 6%.

Once again this is not spectacular, but it's certainly positive and a wealth building expectation. Moreover, this comes from a company with a four-decade-plus streak of increasing its dividend, an overwhelmingly profitable enterprise and a long-term tailwind in the way of an aging population that requires the company's services.

Furthermore, should things go a bit better - say 10% or 13% growth (as analysts' project) or a higher multiple - the investment results can quickly move from "reasonable" to rather impressive. Just because a great deal is not being offered does not mean that a fair one is not present. Today, Walgreens is offering a fair shake in relation to its inherent quality and growth prospects.

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

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.