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The Spokesman-Review Newspaper
Spokane, Washington  Est. May 19, 1883

Motley Fool: Medco looks like safe bet for growth

Higher profits on lower revenue is usually not a recipe for success, but for pharmacy benefit manager MedcoHealth Solutions (NYSE: MHS), that could be just what the doctor ordered.

You see, PBMs make their money by saving health insurers and employers money. Selling generic drugs results in less revenue due to their lower cost, but they result in more profits.

In the third quarter, generics made up 71.6 percent of prescriptions dispensed, up 3.9 percentage points from the year-ago quarter. The coming wave of generic drugs hitting the market should drive that number higher. Medco is looking for earnings-per-share growth of 12 to 17 percent next year and expects 2012 to have the largest contribution from new generic introductions in the company’s history.

Since PBM businesses are so valuable, insurance companies that manage their own drug business in-house might sell or spin them off, to unleash the value for investors, as a few have already done. If they sell those businesses to current PBMs, it would boost the purchasing power of the PBMs, contributing to their bottom lines.

But we’re getting a little ahead of ourselves. For now, investors should just know that Medco and its peers look like they have substantial growth left in them. (MedcoHealth Solutions is a “Motley Fool Stock Advisor” pick.)

Ask the Fool

Q: What’s the financial meaning of “liquidity”? – R.M., Modesto, Calif.

A: There are several meanings. It can refer to a company’s cash and assets that can be quickly converted into cash (such as money market funds and investments in stocks and bonds), minus its short-term debt.

Companies with high liquidity can be less risky, but they might also grow more slowly, as assets that could be used to grow the business are instead kept readily accessible.

Liquidity also refers to a stock’s ability to handle a large volume of trading without big price swings. Major investors such as mutual fund managers care about this because if they want to buy a million shares of something, they don’t want their purchases to start driving up the stock price before they finish buying.

Imagine the Free Range Onion Co. (ticker: BULBZ). If it has 5 million shares outstanding at $10 per share, there’s only $50 million worth that the market can buy or sell. If some of that is owned by company insiders, then even fewer shares are available. Compared to many large firms that trade more than $500 million or $1 billion worth of shares per day, it’s tiny, volatile and illiquid.

Q: If I buy shares of a stock after its “date of record” for a stock split, but before the actual split, will I get the additional shares? – G.R., Dallas

A: Yes. The person who gets the benefit of the split shares is one who owns those shares on the day of the actual split, the pay date. As long as you’re holding the stock when it splits, you’ll get your due. The record date is mainly for accounting purposes.

My dumbest investment

My dumbest mistake was buying Sirius at its high and then buying again when it dropped 5 percent, just to see it drop another 10 percent. Dumb. I thought that satellite radio was really going to take off. – J.K.M., online

The Fool responds: It looks like you bought your shares around $7 apiece and sold them before they sank to $6. That’s good, since the shares proceeded to fall below 12 cents at the end of 2008, after the company merged with XM Satellite Radio and became Sirius XM Satellite Radio. Even now, shares are still below $2.

It’s a big mistake to assume that a stock is a bargain just because it fell, or to think that it won’t keep falling. Very often, stocks fall for good reasons, such as when they face tough competition, have steep debt, are losing market share or are running out of cash.

The newly combined radio company has both fans and skeptics today. Some are happy to see revenue rising, but others worry about competition from Internet radio and smart phones.