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Spokane, Washington  Est. May 19, 1883

The Motley Fool: CVS Health has a healthy future

The Motley Fool

It’s been a tough road recently for shareholders of drugstore giant CVS Health (NYSE: CVS). The company has shown moderate results in its front-of-the-store business (think shampoo, diapers, soap, chips and beer), with comps (sales at stores open more than a year) falling 1 percent during the most recent quarter. But the pharmacy business keeps humming along nicely, with comps rising 3.4 percent during the same time frame.

The reason for the stock’s recent fall has to do with pharmacy accounts leaving CVS and migrating over to rival Walgreens Boots Alliance. Prime Therapeutics - the nation’s fourth-largest pharmacy benefits manager - and Tricare - which provides insurance to active-duty and retired military personnel - decided to use Walgreens to meet their members’ prescription needs. Those changes caused CVS to lower its expectations for the coming year. The stock has already fallen 30 percent from its May highs.

But you can’t ignore what a cash cow this company is. Over the last 12 months, it has generated $9 billion in free cash flow and used only 20 percent of that to pay its dividend, which recently yielded 2.1 percent. With its price-to-earnings (P/E) ratio in the mid-teens, the stock offers a great entry point for retirees looking for a solid business. (The Motley Fool has recommended CVS Health.)

Ask the Fool

Q: Can a company be a poor investment even though its revenue is substantial? - R.N., Ocala, Florida

A: It can. Revenue (or sales) represents only a company’s top line. The bottom line, earnings (or profits), is arguably more important, and you reach it only after subtracting expenses such as salaries, supplies and taxes. It’s critical to know how much (if anything) the company keeps as profit, and whether important figures, such as revenue and earnings, are increasing.

Groupon, for example, has roughly doubled its revenue over the past five years, but most of those years featured net losses, not profits. Meanwhile, Tesla Motors’ revenue has skyrocketed over the past five years, with net losses in each.

Neither company is necessarily a bad long-term investment, but it’s important to look beyond just revenue and revenue growth. Rapidly growing companies will often invest all available dollars in further growth, resulting in losses in early years. Even ailing companies can be good investments sometimes - if they turn themselves around.

With all companies, study their financial reports, see if they’re gaining or losing market share, how strong their competitive advantages are, how much faith you have in their management and whether their futures seem promising. Look for red flags such as major legal problems or investigations into accounting. Or just skip them and focus instead on profitable companies.

Q: Why does the stock market’s value fluctuate daily? - T.W., Erie, Pennsylvania

A: The stock market is made up of thousands of companies’ stocks, each of which rises or falls according to what investors expect of them. If, often due to some news, there are more buyers than sellers, a stock’s price will likely rise - and vice versa.

My Dumbest Investment

I’ve made too many dumb investments to remember them all, but my investment in Banco Popular stands out as one of the dumbest. I was using the company’s dividend reinvestment plan, building up my position in the company for a couple of years, right before it crashed hard. I was investing in the wrong sector (banking) at the wrong time (the Great Recession). I lost a bundle on that one. - C.C., online

The Fool responds: It’s easier to see which countries, industries and companies to avoid when you’re looking in the rearview mirror. The credit crisis took many investors by surprise and sank the financial industry for quite a while, putting some companies out of business altogether.

Long-term investors need to expect occasional market downturns and be prepared to ride them out. Diversifying your portfolio across a range of industries (and perhaps countries) can also help. While many banks have recovered nicely, Banco Popular has struggled some. It has recently been looking into selling some nonperforming assets in order to strengthen its balance sheet.

It’s smart to learn how to study companies in industries that interest you. With banks, for example, some measures to assess include book value and net interest margin (which is total interest income less total interest expense, showing how much the bank is making from its lending and borrowing). Learn more about banks and perhaps favor conservatively run ones.