Trading on headlines can be some of your best investments on the long- or short-side. Investors get so caught up in the herd mentality that even headlines with little real fundamental importance can lead to massive swings in a stock’s price. 

When fundamentals reassert themselves, the shares can swing quickly in the other direction and investors stampede back into the stock to drive the price even further.

#-ad_banner-#One of the most common headline risks for U.S. companies is litigation. For some, lawsuits have almost become a normal course of business to protect a company’s patents, contracts or business model.

One trading target recently saw its shares plummet on a lawsuit by its largest customer. The company is a market share leader in an industry with strong demographic tailwinds, but investors have headed for the exit on a lawsuit that may turn out to be insignificant. 

Shares are trading at an 18% discount to fair value and the longer-term outlook is much higher. 

In The War On Rising Healthcare Costs, This Leader Could Broker A Truce
Express Scripts Holdings (Nasdaq: ESRX) is the largest pharmacy benefits manager (PBM) in the United States through a mail-order pharmacy and network of retailers. The company processed more than 1.3 billion claims last year, giving it pricing power over drug makers as well as scale advantages to keep costs low. 

As the government and seniors more closely scrutinize the increase in drug costs, Express Scripts’ ability to negotiate lower prices with drug makers could help it to gain market share and become a voice for the industry.

Sales have grown at a stable 2.7% over the last three years and should continue to do well on expanded healthcare coverage and aging demographics. Customer retention is above 95% in a non-cyclical industry with high switching costs. Against calls by many investing gurus like Bill Gross and Jack Bogle for weaker market returns over the next decade, shares of Express Scripts should continue to grow sales and cash flow.

Beyond the benefit as a defensive stock, the company is a cash flow machine and generates over $5 billion in operational cash flow annually. It’s been using this cash to pay down debt and on an aggressive repurchase program, buying back over $14 billion in shares over the last three years. The company has bought back 17% of its shares over the last three years, helping to send earning per share up 12.5% on an annualized basis.

Headline Risks That May Turn Out to Be Not Worth The Headline
Stocks like Express Scripts with rock-solid fundamentals and strong outlooks usually trade at a premium to competitors, so it can be difficult finding an entry point where the shares are undervalued. Investors were handed just such an opportunity earlier this year.

Shares plunged in January and have been under pressure since then on a lawsuit filed by its largest customer. 

Health insurance manager Anthem (NYSE: ANTM) stated publicly in January that it wasn’t happy with the price it was paying for drugs through Express Scripts. The tension escalated with a lawsuit filed in March seeking restitution or a break in the ten-year exclusivity contract.

ESRX paid Anthem (then WellPoint) $4.7 billion in 2009 to set annual drug pricing contractually rather than on market rates. An upfront payment is uncommon but likely was meant to lock in the pricing. The contract allows for periodic reviews of prices and the potential for adjustments on good-faith negotiations between both companies.

Anthem now says that it is being forced to pay $3 billion more annually than it should and that Express Scripts isn’t negotiating fairly. Anthem hasn’t provided detail on how it’s calculating the overage, hiring a small consultancy practice to come up with the figure. The contract locks Anthem in through 2019 and it may be hard to prove Express Scripts isn’t acting in good faith. ESRX isn’t obligated to lower its prices, only to act in good faith during negotiations.

Anthem accounts for 14% of sales, but even if ESRX loses that it still trades for an enterprise value of 0.72 times sales on 2016 expected sales, the same enterprise valuation on shares of competitor CVS Health Corporation (NYSE: CVS). Either way, odds are that some kind of reconciliation will be reached. Anthem could have a tough time backing up its claims and industry consolidation has made Express Scripts one of the few choices in PBM.

Investors have fled Express Scripts on the uncertainty over its largest customer and shares trade for an 18% discount to the fair value above. Beyond the immediate discount to fair value, a strong outlook and cash return could take shares much higher.

Risks To Consider: Shares of Express Script could remain undervalued until the uncertainty around the Anthem lawsuit is cleared from headline risks.

Action To Take: Take advantage of the drop in shares of Express Scripts to take a position in one of the strongest names in healthcare for strong upside to fair value and long-term growth.

Editor’s Note: A new life-saving cancer “miracle drug”… Google’s shocking next business venture… a surprising new wearable tech likely to outsell the Apple Watch 3-to-1. Click here to get all 10 of our shocking predictions for 2016, and the game-changing companies making them a reality, in this brand new report — absolutely free.