Shares of CVS Health (CVS 0.21%) have been falling sharply this month after investors were unimpressed with the healthcare giant's latest earnings numbers. The sell-off has been so extreme that not only is CVS trading near its 52-week low, but the stock is now at levels it hasn't been at since 2020. It seems to be trading at a high discount, and with the big decline in price, its dividend is now yielding 4.8%, which is far higher than normal.
Is the sell-off warranted, and is CVS Health in trouble? Or is this an overreaction from the markets, and has the healthcare stock become an incredible bargain?
Big earnings disappointment behind the recent fall
On May 1, CVS Health reported its first-quarter earnings numbers. On the top line, things looked fine, with CVS reporting revenue of $88.4 million for the three-month period ended March 31. That represented a year-over-year increase of 4%.
The bigger problems were its rising expenses. Not only were insurance costs higher than expected, but its profits were underwhelming, and it also reduced its guidance for the year. Collectively, these factors gave bearish investors plenty of justification for selling the stock.
A key metric that was concerning was the medical benefits ratio, which tells investors how much a company is paying out in medical claims versus the premiums it is collecting. The higher the ratio is, the higher the proportion of costs, which means operations were less profitable. For CVS' health benefits business, the ratio was 90.4%, versus 84.6% a year ago. The company blames this increase on greater Medicare utilization during the period, an additional day in 2024, and a drop in its Medicare Advantage star ratings.
Then there was the problem of CVS' guidance. Previously, the company was forecasting that its diluted earnings per share (EPS) would be $7.06 or higher. Now, however, the company has adjusted that to $5.64. CVS says that this is based on the assumption that the "utilization pressure" in the health benefits business will continue throughout the year.
CVS stock is cheap, but is it a value trap?
Shares of CVS are trading at less than 10 times the company's trailing earnings. And that's far below what the stock has averaged over the past decade.
CVS PE Ratio data by YCharts
At first glance, the stock does appear to be a deal. Another positive is that while CVS did adjust down its guidance for 2024, its dividend should still be safe. CVS pays its shareholders $2.66 in dividends over the course of a full year, which is still well below the $5.64 in EPS (or higher) that the company is expecting to hit this year.
This isn't unusual territory in healthcare. Earlier this year, shares of health insurer UnitedHealth fell as it dealt with rising medical costs as well. CVS is in a similar situation these days, with investors spooked by large increases in expenses.
But utilization rates can change, and while the company's medical benefits ratio was high this quarter, that doesn't mean it can come down and improve over time. Investors may have been a bit harsh in dumping an already cheap stock in CVS. But oftentimes when there's an underwhelming quarterly performance and a sharp downgrade in guidance, that can be a recipe for disaster.
Should you invest in CVS Health today?
I don't think CVS Health stock is a value trap. The company simply looks to have underestimated utilization rates and costs. There isn't anything fundamentally wrong with the business to suggest that investors are taking on significant risk by buying shares of CVS.
Although it's a bit of a contrarian pick right now given all the bearishness, I think CVS has the potential to be an underrated buy for the long haul. The stock's low valuation gives investors a healthy margin of safety should things not go as planned and it takes CVS longer to turn things around and improve on its margins. But with a broad and growing healthcare business, CVS still makes for a good long-term investment.
It'll take some patience, but this is a stock I'm confident can generate great returns for investors given the low levels it trades at today.
