CVS vs. Walgreen’s

I’ve always been intrigued by the battle between Walgreen’s (WAG) and CVS (CVS). Both are great companies, and both have made lots of money for their shareholders. Walgreen’s, however, is definitely the Marcia to CVS’ Jan (we won’t even discuss Rite Aid’s Cousin Oliver). Thirty years ago, you could have picked up Walgreen’s stock for just 12 cents a share (that is, adjusting for seven 2-for-1 splits). Today, you’d be sitting on a 40,000% gain.
Not surprisingly, WAG usually trades at a premium to CVS. But the question I’m always asking is, how much? Right now, WAG is going for 28.7 times trailing earnings while CVS is going for 21.6 times trailing earnings. So that’s a premium of 33%. Is that fair?
Sometimes the premium has gotten as high as 100%. Last November I notice that the premium got to 50%, which I thought was way too large. I was right. Since then, shares of CVS have done fairly well, and they even made a new high today. WAG, on the other hand, slumped until May and has started to bounce back recently
I think a lot of Walgreen’s premium is due to its consistency. If people know you can deliver the goods, they’ll pay extra for it. Coke (KO) is a great example of a consistency premium. For years, Coke was always slightly overpriced by most reasonable valuation measures. But since it always stayed overpriced, there was no harm. That is, until it stopped being so consistent. Today, shares of Coke are worth less than half of what they were eight years ago. Pepsi (PEP) is up about 30% and is at a new high today as well.
Paying for consistency is another way of investing in risk. The problem with measuring risk is that it’s highly subjective. What I consider risky may not be to you. The “return” side of the equation is pretty simply. We should all be able to agree on what a 40,000% return looks like.
As I like at CVS and Walgreen’s, I don’t see how the market can justify a premium any larger 15%. I’m still staying away from Walgreen’s.

Posted by on July 12th, 2006 at 2:03 pm


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