3 Reasons Warren Buffett Should Buy CVS Health

By Markets Fool.com

Image source: DonkeyHotey via Flickr Creative Commons.

Continue Reading Below

Warren Buffett is one of the greatest stock pickers of all time. The Oracle of Omaha has made an absolute fortune for himself and his investors by buying shares of companies with durable competitive advantages and favorable growth prospects for a fair price.

Knowing that, I think retail pharmacy giant CVS Health displays nearly all of the traits Buffett looks for in a good investment. Below are three reasons it wouldn't surprise me to see Buffett one day add CVS Health's stock toBerkshire Hathaway'sportfolio.

1. Durable competitive advantages

CVS Health's business is divided into two main parts: a retail empire and a pharmacy benefit management, or PBM, business. Both of these business segments enjoy the strong competitive positions Buffett loves to see in a good investment.

CVS Health's PBM business generates revenue by helping other large institutions -- think employers, unions, and governments -- control their spending on pharmaceuticals. This business segment is high-volume and low-margin, where scale is critical. The bigger the business becomes, the more bargaining power it holds with drugmakers.

Continue Reading Below

With more than 80 million members, CVS Health runs the second-largest PBM network in the country, behind onlyExpress Scripts.When adding in the purchasing power of itsretail division, the company's bargaining power is massive, which it uses to negotiate favorable terms for its customers.

Those customers have become extremely reliant on CVS to help them keep their pharmacy costs in check. That's evidenced by its customer retention rate of 97.3%, which shows just how much value customers get from its services. That gives this business segment a wide and enduring moat.

Image source: CVS Health.

CVS Health's retail pharmacy business segment is also in great shape. With more than 9,600 stores in its empire, the chain currently holds a market share of 23.9%, a sizable lead over the rival 19.5% market shareWalgreens Boots Alliancecurrently claims. Importantly, CVS's market share actually grew by 245 basis points recently thanks to last year's $1.9 billion purchase ofTarget's pharmacy and clinic business, a move that expanded its retail footprint count by more than 20%.

Retailers in general have been under a lot of pressure in recent years from e-commerce threats, but I think CVS Health's retail stores are well-positioned to continue to thrive. The company's network of in-store clinics -- called MinuteClinics -- offer basic medical services to teat minor ailments, a service e-commerce players simply can't match. CVS health currently has 1,100 of these MinuteClinics in operation and has announced plans to have 1,500 open within the next few years. That will only further protect its business from competition.

Beyond the clinics, management has been investing in technology to make its stores more convenient for customers. A good example of that is ScriptSync, its program designed to make it easier for patients with multiple prescriptions to get their monthly refills at the same time. ScriptSync was launched less than a year ago, but the company already boasts more than 1 million customers.

Add it all up, and CVS Health has built itself a wide and enduring moat I think Buffett would love.

2. Favorable long-term growth prospects

CVS Health is currently digesting two monster acquisitions that should ensure that its strong growth remains strong for years to come.

The first was the Target buyout mentioned above, which the company is still in the process of rebranding under the CVS Pharmacy name. Once the transition is completed, the company will start to market to the millions of Target customers who do not yet use CVS Health's services.

Image source: CVS Health.

The second big move CVS Health made was paying $12.9 billion to buy Omnicare, a provider of pharmacy services to long-term care facilities. This is an area CVS Health believes is poised for fast growth in the coming decades. When you consider that 10,000 baby boomers are turning 65 every single day, you might agree. Time will likely show that building up its presence in the assisted-living and long-term care facility markets was a smart move.

When adding these acquisitors to its other growth avenues, I think the company stands a good chance of achieving its long-term earnings-per-share growth target of 10% to 14% growth.

3. A history of treating shareholders well

Finally, Buffett loves to invest in companies that treat their shareholders well, and a look at CVS Health's history demonstrates that it does just that.

The company has been paying out a dividend for more than 30 years, and it's growing it quickly, too. Just last year, management bumped up its dividend by a strong 21%, consistent with its commitment toincrease its dividendannually.

Despite giving shareholders a raise, thecompany'spayout ratio is a healthy 31.9%, which is a still below its longer-term target ratio of 35%. That means the company still has room left to grow its payout, especially since earnings are still rising rapidly.

Beyond the dividend, CVS Health is also aggressively repurchasing its own shares. Last quarter alone, management bought back $2.1 billion worth of its own stock. Looking ahead, the company plans to buy back another $1.8 billion for the rest of the year.

Here's a great visual that shows how these efforts have rewarded shareholders over the past few years:

CVS Dividenddata byYCharts.

Between dividends and repurchases, CVS Health is planning on returning about $5 billion to shareholders this year, which is more than 90% of its total free cash flow. That speaks volumes about how committed the company is to treating its investors well.

A stock Buffett could love
CVS Health holds a dominant competitive position in two growth markets, has long-term trends working in its favor, and has ample resources to continue showering its investors with dividends. Considering all of that, I think CVS Health is exactly the kind of company Buffett is looking for, and I could easily see him adding shares to his portfolio one day.

The article 3 Reasons Warren Buffett Should Buy CVS Health originally appeared on Fool.com.

Brian Feroldi has no position in any stocks mentioned.Like this article? Follow him onTwitter where he goes by the handle@Longtermmind-setor connect with him on LinkedIn to see more articles like this.The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and Express Scripts. The Motley Fool recommends CVS Health. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.