Should I be adding to CVS and Walgreen’s Later This Month?
Last week, I received questions from a few readers about CVS and Walgreen’s. The share prices behind both companies are taking a beating recently.
If share prices are low when the next newsletter comes out on Sunday, March 24th, there is a high chance that I will add at least a share of Walgreen’s to the Dividend Growth Investor Portfolio. There is a low chance that I will add to CVS however.
I like the valuation and earnings trends for CVS. However, I do not like the dividend freeze that was enacted in 2018, following the acquisition of Aetna. As a dividend investor, I look for companies that have managed to grow dividends for a certain number of consecutive years. This shows to me a commitment to raising dividends. This commitment means something when it is backed by rising earnings per share. Under an ideal scenario, a company will grow earnings and distribute a rising annual dividend per share. I want to buy a share in such a company, and enjoy rising earnings, dividends and share prices over time. Once this virtuous loop ends however, I start asking myself if something is wrong with the business.
As a result, when I see that management is no longer committed to growing dividends, it shows that they do not have a lot of conviction behind their earnings per share growth in the near term. By keeping dividends unchanged, management is really telling me that things are cloudy on the horizon, so that they do not believe that future earnings will justify growing the dividend. Without annual dividend increases, I am essentially stuck wondering whether something is wrong with the business, or this is just a temporary situation.
It is very likely that this is just a temporary measure, in order to get the balance sheet under control, reduce debt, integrate acquisitions etc. Once CVS starts raising dividends again, I will consider adding to the stock again. For my investment model to work, I need companies at an attractive valuation, growing earnings and growing dividends. That way I can keep investing $1,000/month, reinvesting dividends, and enjoying the organic dividend growth that will propel me to $1,000 in monthly dividend income within 10 – 15 years. If I invest in companies that never raise their dividends, it will take longer to reach my stated newsletter goal of generating $1,000 in monthly dividend income.
It is very likely that I am missing out on an incredible bargain today, by not adding to CVS. However, I also see risks of a dividend cut being increased as well. A lot of dividends cuts in the past have occurred in situations with a lot of debt, high payout ratios and major acquisitions.
My basic thought process is that if CVS prospers, I already have exposure to the stock, so I should do ok. If CVS fails, I will likely lose what amount I own there, but would have protected my new capital from going into a sinkhole. Plus, I would have allocated dividends elsewhere, and increased the diversification of my portfolio.
That being said, I am still considering Walgreen’s as an addition to my portfolio. I may even consider adding further after that. I have a high allocation to Walgreen’s, and want to avoid overly concentrating my efforts in once company. I like diversification, which is why I want to own as many companies as I can find, and also to limit their weight in my portfolio to a reasonable amount. I also like spreading my purchases over several months, in order to take advantage of potentially lower prices. The downside to this strategy is when share prices start going up in a linear fashion, and I haven’t build out my full position in a security. However, I believe that there are always good securities to be selected at the right valuation. My goal as a portfolio manager is to manage my risk properly.
I believe that my upside will take care of itself. I do want to place some fail-safe mechanisms in portfolio construction process, in order to reduce the magnitude of my errors when they occur. I also believe in maintaining a disciplined approach when investing my hard earned money. This is why the odds of me adding to CVS Corp are low.