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Profit Leader From Health Care

08/29/12 09:24:55 AM
by Billy Williams

Reform in health care is coming, and one company is at the forefront from profiting from it.

Security:   ESRX
Position:   Hold

Express Scripts Inc. (ESRX) is a company involved in providing pharmacy benefits management services to pharmacies, companies, insurance providers, and associations. Earlier in 2012, the company bought out its rival, Medco Health Solutions, for $29 billion, which contributed to better-than-expected second-quarter results while also putting ESRX in a plumb position to take advantage of the upcoming health-care reforms as it relates to pharmacy and drug management. See Figure 1.

Positive reviews by analysts following the second-quarter reports left Wall Street feeling justifiably optimistic about the stock's prospects with glowing prospects as its leadership position in the market left ESRX as the go-to company for the current reforms.

With a stellar return on equity of 49%, leading up to second-quarter earnings 24% higher than analysts' estimates and beating sales estimates by a whopping 144%, ESRX has jumped up in the stock rankings and become a noted leader in the current market type. Analysts have now stated that they believe the stock will have growth of 25% for 2012 and 22% in 2013.

This has caused strong accumulation in the stock on the part of both institutions and individual investors, with mutual funds adding the stock to the portfolio. In the second quarter, a record 1,790 mutual funds had a position in the stock, establishing that Wall Street has a positive view of the company's future prospects.

FIGURE 1: ESRX. In early 2011 (#1), ESRX began to form a base pattern, which was triggered, but then European debt fears took the market down and below ESRX's price low (#2), resetting the base count.
Graphic provided by:
Price action leading up to the current earnings reports show a stock that has outperformed the market as well as weathered some of the jagged drops in the market as well. In early January 2011, ESRX began to form a base of the next several weeks and offered a buy point of around $57, which was triggered in May of that year. But after several weeks, price rolled over and gave way to weakness as European debt fears had a disastrous effect on the market; investors began to flee from the market's volatility and downward price action.

Price declined below the mid-March price low in 2011, resetting the base pattern for another long entry. On October 5, 2011, price established its new low as it began to climb higher and form a cup & handle pattern followed by the cup portion of the pattern, setting a new buy point at $52.90, which was triggered on February 23, 2012. See Figure 2.

FIGURE 2: ESRX. On October 5, 2011, the stock began to trade off its low and form a cup & handle pattern. Two buy points were triggered (points A & B) as the stock traded up through the $60 resistance level to become minor support. The $60 price level is now in a position to act as the jumpboard for ESRX to climb to new highs and lead the market higher if the bulls gain control again.
Graphic provided by:
The stock began to rise before pulling back below its entry point due to the effects of a weak market but later resumed its upward movement, eventually offering an additional buy point.

Since the stock didn't rise 20% above its buy point of $52.90, the stock formed a second entry point at 5% above this point at $62.03. Later, ESRX traded %6 below the second entry of $62.03 but then gapped higher on news of higher sales growth on August 8, 2012.

This second buy point is the most telling on the future prospects of the stock's price action itself, since there has been a noticeable line of resistance at $60 for this stock. Now, ESRX has traded up through it and is above it; this $60 level can now turn into minor support for the stock and lead it into higher territory.

The only negative for ESRX is that it has an incredibly high debt-to-equity reading of 286%. If interest rates rise, it could have seriously negative consequences on the company's earnings and eat away at its profits. If the current market changes due to rising interest rates, then this stock should shift from your list of long candidates to your list of potential shorts.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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