Saturday, January 10, 2009

Walgreen vs CVS

Walgreen and CVS are the largest retail drugstore chains in the US. As such, their financials are often compared. With a P/E of 13.50 for CVS versus just 12 for WAG, the investment community gives CVS the edge due to its faster growing sales and profits. But such a superficial approach to determining the better investment ignores the most important question when it comes to selecting an investment: returns on invested capital.

Any investment a company is required to make is less money in the hands of shareholders. Therefore, if one company can generate the same profits as the other but using much less capital, its shareholders will benefit. For a full discussion of this concept, see the discussion here.

In the case of WAG and CVS, here are the return on invested capital numbers for 2008:

Note the major difference in ROIC for these two companies. A dollar invested in WAG appears to go much further. One caveat to note is that these are only 2008 numbers, and as we've discussed before, to properly analyze a company and its management, it makes more sense to consider several years worth of data to remove the effect of unusual items. (For example, CVS has experienced integration costs due to a recent acquisition.)

As a result of its strong returns and lower capital requirements, WAG was able to pay a dividend higher than that of CVS in 2008 despite lower net income levels. If this difference in returns is persistent, CVS may show higher profits, but would nevertheless be the inferior company for shareholders.


Anonymous said...

Just like with KO and PEP a few weeks ago, you are comparing apples to oranges. CVS is CVS Caremark. Caremark is a PBM, with a very different financial profile. WAG could be compared to RAD, or (until recently) Longs or Eckerds.

Saj Karsan said...

Hi Anon,

You are right, these companies are not identical. However, ROIC is a metric that can be used to compare companies across different industries as well. The point is, some companies/industries offer better returns than others, and investors should understand these returns before investing in any company.