What If Walgreens Wasn't Offering A 'Fair Shake?'

| About: Walgreens Boots (WBA)
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In a previous article, I detailed why Walgreens could be offering a "fair shake".

Of course, an individual ought to come up with their own expectations and may disagree with the notion of "fair".

This article details some possibilities if it is your view that shares of Walgreens are not offering a reasonable deal at the moment.

In a previous article, I detailed how Walgreens (NASDAQ:WBA) appeared to be offering a "fair shake." The quality of the business is quite high, the earnings and dividend record very impressive and today's valuation in comparison to the firm's expected growth rate appears reasonable. There have been times when shares have looked (and indeed been) exceptionally compelling in the past. Today, you don't exactly have a valuation that yells out to you, but this shouldn't be misinterpreted to mean that there is no possibility for solid returns going forward.

The conclusion of that previous article was that today's valuation offered a "fair shake." Of course, that's just one opinion. Instead of blindly accepting an investing view, it can be beneficial to come up with your own assumptions, degree of confidence (or lack thereof) and determine personally whether or not a particular investment appears attractive. In that vein, let's suppose that we don't believe that shares of Walgreens are offering a fair deal and instead are a bit higher than you would like (price and valuation-wise).

Let's think about two scenarios, with the first being not already owning shares of Walgreens.

If you don't believe in the business - perhaps you suspect that competition will best the company or something of the sort - it's unlikely that a marginally lower (or materially lower for that matter) price and valuation would be interesting to you.

However, if you believe that Walgreens is a fine business with just a slightly higher-than-you-would-like valuation, you have some options available to you. (In this case literally.)

Perhaps you believe $80 is too high for Walgreens (call it an anticipated earnings multiple near 18), but something around say 16 times expected earnings or $72 would be much more reasonable. If you have that particular view (and capital to allocate), you have some alternatives.

One thing that you could do is set a limit order for that price. If shares reach your comfort level, you buy shares. If not, you keep your capital and don't own shares.

Another alternative is to make your sentiment (and cash readiness) known - selling a put option at a price in which you'd be happy to own shares.

Here's a look at some available put options for Walgreens for the January 2017 expiration date:

Keep in mind that these numbers are for the next five months and note that I have no affinity for this expiration date. Many investors prefer shorter time frames, but the idea is to get a feel for what's out there.

The strike price is the price at which you're willing to buy 100 shares of Walgreens. The "net" premium takes the most recent bid less $0.15 per share for transaction costs and fluctuations. The premium yield indicates the upfront cash flow yield that you would receive for making this agreement over the 5-year period. Finally, the "discount" column details how much lower your cost basis would be as compared to current share price.

So as an example, let's imagine that you're not particularly eager to buy shares of Walgreens around $80 per share, but your enthusiasm would be revitalized with a share price in the low-$70s. Something you could chose to do would be sell the $72.50 put option, as an example, to get paid to express your willingness to buy shares at that price.

Once you made that agreement, immediately you would receive ~$230 (less fees) as upfront cash flow (which may be taxed differently than qualified dividends). There are two basic outcomes in this scenario: either the option is exercised or it is not.

If the option is not exercised, you keep your upfront option premium and the $7,250 you set aside to buy 100 shares is once more "released" and able to be redeployed. This easily beats the non-return that would be generated by keeping cash handy and setting a limit order that is never executed. However, there are a couple of things to keep in mind.

For one thing, you could generate a 3.2% return over the course of five months by not buying shares of Walgreens, only to see the price jump up 10% or 20%. In other words, buying outright instead of agreeing to buy at a lower price could prove to be a "better" decision in both the short and long term.

The second thing to consider is your return in comparison to your applicable alternatives. Against today's short-term CD, the option premium easily wins out. Against a comparable security? The benefit isn't quite as clear-cut.

The second basic outcome is that the option would be exercised and thus you would buy shares. In this case, your cost basis would be near $70, representing a discount of close to 13% as compared to today's price. A lot of people will point out that this would not prevent against a loss, which is true. Shares could drop to $60 and you're "stuck" buying at $72.50.

However, I would like to point out that this thing ought to be considered beforehand. If you come up with a price that you'd be happy to buy and hold shares at, lower bids shouldn't distract you from your longer-term goals. It's similar to if a house you like is selling for $80k and you happen to get it for $70k. Just because I walk by and offer $60k, this doesn't mean you now have to sell it at that lower price or even pay attention to that outside bid.

Those are some alternatives if you don't yet own shares. You could watch and see what happens, set up a limit order or else get paid to agree to a price that you'd be happy with. All three have different advantages and disadvantages, the idea is to be cognizant of your investment flexibility.

If you already own shares, here too you have options - once again literally. If you have the view that shares are trading at a price that is a bit higher than you'd be happy with adding "fresh" capital to, you could sell, hold or agree to sell at a higher price. Naturally, you'd also have the alternative to buy more as well, and while this might apply in limited circumstances, it would not mesh with your hypothetical sentiment.

A lot of investors choose to hold in this situation, which I find to be a perfectly rationale decision. Outright selling involves fees, taxes and finding an applicable replacement that can take away from any perceived benefit, especially given the uncertainty in the investing world.

However, you can also agree to sell at a higher price. You could accomplish this by setting a limit order at a price at which you deem is fair, or else get paid to express that sentiment by selling a call option.

Here's a sampling of call options that are available for Walgreens using the same January of 2017 expiration date:

The methodology here is the same as depicted above, with the natural exception that this table details the price at which you would be willing to sell 100 shares of Walgreens. Moreover, the yield is based on the current value of 100 shares and not a varying amount of cash required to make the agreement.

So as an example, you could agree to sell shares at say $85 over the next five months under the pretext that if you think $80 is a touch high, surely $85 is higher.

In this scenario, you would receive ~$270 (less fees) for making that agreement. Once more you have one of two basic outcomes that will result: either the option will be exercised or it will not.

If the option is not exercised, nothing changes with about holding your position: you still own 100 shares and you still collect the dividend payments along the way. The only difference is that you also have this ~$270 of "bonus" cash flow that can be deployed as you see fit.

If the option is exercised, you still have your ~$270 in upfront option premium to go along with $8,500 (less fees) in sale proceeds. The nature of the latter gain will depend on your holding time horizon. Additionally, you may or may not also receive dividend payments along the way depending on when the option is exercised.

The upside to this agreement is that you either increase your cash flow with a security you're happy to hold or else sell at a price that you are content with. The downside is that the agreement effectively "caps" your upside; in this particular case to ~9% - ~10% in the next five months depending on dividend payments. Should shares later trade at say $100, you're "stuck" selling at $85. This is a very real risk and ought to be considered appropriately.

In short, shares of Walgreens could very well be offering a "fair shake" as it relates to the valuation, quality and growth prospects of the business. Of course, you need not take that same view.

The point of this article was to demonstrate that you have options available to you (often literally) should you believe that the valuation is a bit higher than what you are comfortable with. Thinking through these alternatives definitely takes more leg work, but it also allows you to tailor your investing strategy a bit more. In general, I'm a strong advocate for "buy and hold;" yet at the same time being aware of ways to enhance your cash flow in a situation where you'd be happy with either outcome can be equally rewarding.

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.