While it is impossible to predict with absolute certainty whether a stock price will go up or down in the future, investors can come up with reasonable estimates of its future returns. To do this, an understanding of what comprises future returns, and how to apply it to individual stocks, is necessary.
The expected total returns of a stock are derived from three sources—a company’s earnings growth, its dividends paid, and any upward or downward changes to its valuation multiple. Picking undervalued stocks with positive growth potential and attractive dividends, can give investors the best chance at generating high returns over time.
Walgreens Boots Alliance (WBA) is an undervalued stock with growth potential and an attractive dividend. As a result, Walgreens Boots could return nearly 20% each year over the next five years.
What is Expected Return?
In a nutshell, the expected return of a stock is the anticipated gain or loss an investor will receive over a given period of time. It includes all capital gains (or losses) from fluctuations in the share price, and any dividends paid along the way. The drivers of a rising or falling share price are a company’s earnings growth or decline, and any changes in the valuation multiple (typically measured as price-to-earnings ratio).
A declining share price results in negative total returns for shareholders, but might actually boost future returns. If a stock becomes cheaper on a valuation basis, investors that buy at a lower price could earn greater returns if the stock rises once again. It is important to remember that stock prices can fall in the short-term simply out of investor irrationality. This appears to be the case regarding Walgreens Boots.
Walgreens Boots stock has declined 12% over the past year, as the company struggles with a weak retail environment and the threat of Amazon entering the healthcare industry. Despite the fact that the stock has produced negative total returns in the past year, investors should not assume it will continue to do so going forward. Walgreens Boots stock could represent an attractive buying opportunity.
How Walgreens Gets To 18% Per Year
First, Walgreens Boots stock appears to be undervalued. The stock currently trades for a price-to-earnings ratio of 12.0. Fair value for Walgreens stock is a price-to-earnings ratio of 16.7, which is its average valuation multiple over the past 10 years. A price-to-earnings ratio of 16.7 would result in annual returns of approximately 6.8%, just from an expanding valuation multiple. This shows the benefit of buying high-quality stocks when they are undervalued.
In addition, returns will be boosted by Walgreens’ 2.5% dividend yield. The company has an excellent track record of dividend growth. It has increased its dividend for 43 years in a row, which makes it a member of the exclusive Dividend Aristocrats list. These are companies in the S&P 500 Index that have raised their dividends for at least 25 years. Walgreens delivered a strong 10% dividend increase for 2018.
Lastly, Walgreens’ earnings growth will add to its total returns. Despite the difficult climate for brick-and-mortar retailers, Walgreens has continued to grow earnings at a high rate. Over the first three quarters of the current fiscal year, Walgreens increased revenue by 11%. Adjusted earnings-per-share also increased by 20% in the nine-month period.
Walgreens should continue to grow earnings at a strong rate over the next several years. It is in an advantageous position, with tremendous competitive advantages. Walgreens is the largest pharmacy retailer in the U.S. and Europe. Aging populations in these parts of the world provide a long tailwind for Walgreens. Pharmacy sales and prescriptions increased 19% and 12%, last quarter, respectively. Thanks to these catalysts, Walgreens could grow earnings by 9% per year over the next five years.
Putting it all together, and Walgreens stock could return 18.3% per year, driven by 6.8% returns from valuation expansion, the 2.5% dividend yield, and 9% earnings growth. This is a high rate of return and makes Walgreens an attractive dividend growth stock.
Ben Reynolds is CEO of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth stock portfolios for the long run.