Wall Street Analysts Are Bullish On CVS, But Mr. Market Is Skeptical (NYSE:CVS)

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Summary

CVS stock price has dropped 27% over five years.
The Wall Street consensus has been consistently bullish over this period and remains bullish.
The market-implied outlook is modestly bearish.
The current valuation suggests the market anticipates modest growth.
My final rating is neutral.

Portrait of female nurse holding digital tablet at hospital using protective mask — Photo by FG Trade/E+ via Getty Images

Many people think about CVS as a retail pharmacy chain, but CVS Health Corporation (NYSE:CVS) is far more than that. Through the acquisition of Aetna in late 2018, CVS is now one of the largest providers of health insurance in the U.S. CVS is a unique health services provider that provides on-site care in walk-in clinics, pharmacies, and insurance.

At a forward P/E of 9.85, the stock is quite cheap relative to the near-term outlook for earnings. The 2.7% dividend yield is reasonable, although the dividend has not been increased since 2017. The company is prioritizing reducing its debt load (see slide 8 in the linked presentation) rather than growing the dividend. The company anticipates raising the dividend once it reaches certain balance sheet goals, but income investors tend to prize consistent growth, so CVS probably fails the screens for many of these investors.

Price history and basic statistics for CVS (Source: Seeking Alpha)

The projected 3-5 year annual earnings growth is quite low at 6.24%. The stock price has declined 27% in the past five years, and total annualized return (including dividends) is -3.74% per year for this period. The market price of a stock represents the market’s estimate of the net present value of future earnings, and that suggests that the market is not convinced of the potential for higher growth rates.

Wall Street Analyst Outlook

CVS has substantial analyst coverage and the consensus view is very positive. eTrade’s Wall Street consensus calculation, with 13 ranked analysts who have rendered opinions in the last 90 days, assigns a bullish rating and a 12-month price target of $89.30, 20.56% above the most recent closing price of $74.07. The analyst outlooks also have very low dispersion, ranging from a low of $80 to a high of $102.

Wall Street analyst consensus rating and 12-month price target for CVS (Source: eTrade)

The Wall Street consensus outlook compiled by Seeking Alpha is also bullish but has 27 analysts included in the assessment. The consensus price target, $87.15, is 17.7% above the most recent close. Of the 27 analysts, 13 are very bullish and none assign a rating less than neutral.

Wall Street analyst consensus rating and price target for CVS (Source: Seeking Alpha)

It is notable, however, that the very bullish tilt in analyst opinions has been present over the past five years, a period over which the stock price has fallen 27%.

Distribution of Wall Street analyst ratings for CVS over the past five years (Source: Seeking Alpha)

Market-Implied Outlook

The prices of call and put options represent bets on the probability that the price of a stock will rise above (call) or fall below (put) a specific level (the strike price) over a certain period of time (from now until the expiration date). The prices of calls and put for a range of strike prices provide a great deal of information about the market’s consensus assessment of the probabilities of different outcomes. By analyzing the prices of calls and put for different strike prices and the same expiration date, you can calculate a probabilistic return outlook that reconciles all the different options prices. This is the market-implied (aka option-implied) outlook. This approach is used in a range of applications in quantitative finance. For those who are unfamiliar with the concept, I have written an overview post that provides examples and links to the finance literature.

For this post, I have analyzed options on CVS that expire on January 21, 2022, generating the market-implied price return outlook for the next 9.34 months. The market-implied outlook is presented in a standard probability distribution, with probability on the vertical axis and price return on the horizontal axis (from most negative on the left to most positive on the right).

Market-implied price return probabilities for CVS for the next 9.34 months (until January 21, 2022) (Source: author’s calculations using options quotes from eTrade)

The market-implied outlook is moderately bearish in that there is a pronounced peak in the probability at -9.38% return. Collectively, the options market indicates that the most probable price returns for the 9.34 month period are negative. The annualized volatility derived from this distribution is 25%, which is low for an individual stock.

I find it helpful to visualize the information in the chart above slightly differently. I rotate the negative return side of the distribution about the vertical axis, making it much easier to see the relative probabilities of positive and negative returns of the same magnitude (see chart below).

Modified visualization of the market-implied price return probabilities for CVS for the next 9.34 months (until January 21, 2022) (Source: author’s calculations using options quotes from eTrade)

This chart makes it easy to see that the probability of negative returns is consistently higher than for positive returns of the same magnitude. For extreme returns (larger than +/- 35% or so), the probabilities of positive and negative returns are very similar (the red dashed line and the blue solid line are almost on top of one another).

The median price return (50% of projected outcomes are above this level and 50% are below) is -3.4% and there is a 57% probability of having a price return less than or equal to zero over the next 9.34 months.

Collectively, the market prices of options suggest that there is a higher probability of negative returns than positive returns for the period from now until January 21, 2022, a bearish view. That said, this is a fairly modest bearish tilt.

For income investors, selling covered calls on CVS looks reasonable. You can sell a call option with an $82.5 strike and an expiration of January 21, 2022 for $2.64. Selling a covered call (buying the stock and selling this call option) will provide 3.5% in option premium income while still retaining 11.4% in potential price appreciation. The market-implied outlook indicates that there is a 76% probability that the price of CVS will not exceed $82.20 for the 9.34 month period. This means that there is an estimated 3-in-4 probability that an investor who sells a covered call at this strike price and expiration date will get to keep all of the price appreciation from the stock, all of the accrued dividends (2.7% annually), and the 3.5% in option premium income. There are a number of ways this trade can play out, but 6% to 7% in total annualized income (from dividends and option premium income) along with about 10% in price appreciation potential looks reasonable.

Summary

CVS is an integrated health services company. While the company has built out its range of services, largely through acquisitions, the market remains skeptical of the growth potential. The Wall Street analysts are, collectively, very positive on the stock and have been for a number of years. The Wall Street consensus is bullish, with a 12-month price target that is 18% to 21% above the most recent close. There is a high level of consistency in the analyst outlook, which tends to add confidence. The market-implied outlook is somewhat bearish from now until early 2022, with a most-probable price return projection of -9.4% and a median of -3.4%. Balancing the bullish Wall Street analyst view with the moderately bearish market-implied view, my final rating is neutral. For those inclined to be long CVS, covered calls can get you to about 6% to 7% in total income, while still retaining around 10% in price appreciation potential. Given the stock’s modest expected volatility, this is worth considering.

This article was written by

Geoff Considine

5.77K Followers

Geoff has worked in quantitative finance for more than twenty years. Before entering finance, Geoff was a research scientist for NASA. Geoff holds a PhD in Atmospheric Science from the University of Colorado - Boulder and a BS in Physics from Georgia Tech. Neither Geoff Considine nor Quantext (Geoff's company) are investment advisors. Nothing in any commentary here on Seeking Alpha or elsewhere shall be regarded as advice.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CVS over 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.

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