Best Stocks for 2021: Walgreens Boots Alliance Continues to Climb the Charts

Editor’s note: This column is part of InvestorPlace.com’s Best Stocks for 2021 contest. Ben Reynolds’ pick for the contest is Walgreens Boots Alliance (NASDAQ:WBA).

Walgreens Boots Alliance (NASDAQ:WBA) is a global pharmacy-led health enterprise with a large presence in the United States and Europe. WBA is also my pick for the Best Stocks for 2021 contest.

As of July 2, the company’s stock had generated total returns of 23.3% in 2021. This is significantly ahead of the S&P 500 ETFs’ (NYSEARCA:SPY) total returns of 16.8% for the first half of the year.

Walgreens stock has generated solid returns so far in 2021. That said, I believe there’s still potential for Walgreens stock to run higher this year.

Walgreens Stock Still Appears Undervalued

Walgreens’ adjusted earnings-per-share peaked in 2018 at $6.02. In fiscal 2020, the company generated adjusted earnings-per-share of $4.74.

Now Walgreen’s management is guiding for adjusted earnings-per-share from continuing operations growth of around 10% in fiscal 2021. That implies adjusted earnings-per-share from continuing operations somewhere around $4.40.

The company’s earnings-per-share took a hit after the company completed the sale of its Alliance Healthcare business for ~$6.5 billion to AmerisourceBergen (NYSE:ABC). However that move allows Walgreens to eliminate $3.3 billion in debt from its balance sheet and fund future growth initiatives.

The company’s stock is currently trading for a price-to-earnings ratio of just 11.0 using our fiscal 2021 earnings-per-share estimate of $4.40. For context, the company’s historical average price-to-earnings ratio over the past decade was around 15.

A price-to-earnings ratio of under 11 seems too low for a shareholder-friendly company like Walgreens. After all, Walgreens has increased its dividend payments for 45 consecutive years. Plus, the company regularly reduces its share count via repurchases.

Future dividend growth is also very likely at Walgreens. The company’s payout ratio is just 42.5% based on expected fiscal 2021 adjusted earnings-per-share from continuing operations. The company’s low payout ratio gives management room to increase the dividend even if earnings growth is stagnant.

If Walgreens were to return to its historical average price-to-earnings ratio of 15, this would imply a share price of $66 using expected 2021 fiscal adjusted earnings-per-share of $4.40. That’s 37% upside from current prices. And this is still far from the company’s all time high share price; Walgreens stock traded above $90 per share back in 2015.

Walgreens’ Total Return Prospects

Walgreens stock currently has a relatively high dividend yield of 3.8%. This yield — coupled with a low payout ratio and likely dividend increases — should appeal to income hungry investors in or near retirement. That ratio is nearly triple the S&P 500’s paltry 1.3% dividend yield.

From fiscal 2011 through fiscal 2020, Walgreens managed to compound its adjusted earnings-per-share at 6.7% per year. The company has proven it can grow over a wide range of economic environments as evidenced by its 45-year streak of consecutive dividend increases which earned the stock a place on the exclusive Dividend Aristocrats list.

We expect the company to turn around from recent earnings-per-share declines and return to moderate growth. That will lead to earnings-per-share growth of 5% per year going forward for Walgreens.

With 5% expected growth and a 3.6% dividend yield, Walgreens offers investors expected annual returns of 8.6%. And that’s before valuation multiple changes.

A conservative estimate of Walgreens’ fair value is to use a price-to-earnings ratio of around 10 or 11. This would imply the company is trading around fair value now.

But, if the company’s stock retakes its historical average price-to-earnings ratio of around 15 in the next 5 years, shareholders will see much stronger returns. A return to a price-to-earnings ratio of 15 — which isn’t high by any stretch of the imagination — would boost returns by 6.4% annually.

This pegs Walgreens expected total returns at somewhere around 6.5% to 15% annually over the next five years.

Final Thoughts

Walgreens offers investors relatively high expected total returns over the next five years because it is still trading for a reasonable price-to-earnings ratio and has an above-average dividend yield of 3.8%

Additionally, the company has a fairly low payout ratio to go along with a long history of dividend increases. This gives the company’s stock an appealing reward to risk profile.

Walgreens stock should especially appeal to investors looking for safe dividends, an above average yield and a high likelihood of continued dividend increases ahead.

The company’s stock has appreciated so far this year, but that has only brought the stock from being significantly undervalued to being fairly valued (conservatively) or still somewhat undervalued. Walgreens still has the potential to generate strong returns from now through the end of 2021.

On the date of publication, Ben Reynolds was long WBA stock. He did not have (either directly or indirectly) any positions in the other securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Ben Reynolds founded Sure Dividend in 2014. Today, Ben continues to run Sure Dividend to help individual investors build high quality income portfolios. Ben graduated Summa Cum Laude from University of Houston with a finance degree. His work through Sure Dividend has appeared on Forbes, Fidelity, Motley Fool, The Street, Yahoo! Finance and more.