Drug store giant CVS Health Corporation (CVS) reported better-then-expected Q3 earnings on Nov. 6, and the stock powered higher as the turnaround story gains momentum.
Shares of CVS have been in recovery mode since mid-June even as the pharmacy chain struggled to cut costs following its acquisition of health insurer Aetna last year. It can take years for one company to "digest" the company it bought and see the benefits of the acquisition. As CVS expands its Minute Clinic to more store locations, going into this pharmacy will become like going into a "mini emergency room."
The stock closed last week at $72.47, up 10.6% year to date and in bull market territory at 40.1% above its May 17 low of $51.72. The stock set its 2019 high of $72.98 on Friday, Nov. 8. Even after this strength, the stock remains fundamentally cheap with a P/E ratio of 9.58 and a dividend yield of 2.79%, according to Macrotrends.
CVS has now beaten earnings per share estimates in 15 consecutive quarters. The turnaround story began on Nov. 28, 2018, when Aetna announced that the CVS deal to buy Aetna had been completed, setting the stage for CVS to become "the nation’s premier health innovation company."
The daily chart for CVS Health
The daily chart for CVS shows that the stock had been below a "death cross" since Jan. 30, when the 50-day simple moving average fell below the 200-day simple moving average to signal that lower prices lie ahead. This tracked the stock to its 2019 low of $51.72 set on May 17.
As the turnaround story evolved, a "golden cross" formed on Sep. 19. This is the opposite of the "death cross," as a "golden cross" occurs when the 50-day simple moving average rises above the 200-day simple moving average to indicate that higher prices will follow. This buy signal tracked the stock to its Nov. 8 high at $72.98.
The weekly chart for CVS Health
The weekly chart for CVS is positive but overbought, with the stock above its five-week modified moving average at $65.63. This targets the 200-week simple moving average, or "reversion to the mean," at $75.60. The stock has been below the 200-week simple moving average since the week of Nov. 4, 2016.
The 12 x 3 x 3 weekly slow stochastic reading ended last week at 89.32. If this reading rises above 90.00, the stock becomes an "inflating parabolic bubble." During the week of April 26, this reading was 9.71, which was below the 10.00 threshold making the stock "too cheap to ignore."
Trading strategy: Buy CVS stock on weakness to its monthly value level at $59.46. Reduce holdings on strength to the annual risky level at $106.84.
How to use my value levels and risky levels: Value levels and risky levels are based upon the last nine monthly, quarterly, semiannual, and annual closes. The first set of levels was based upon the closes on Dec. 31, 2018, and the original annual level remains in play. The close at the end of June 2019 established new semiannual levels, and the semiannual level for the second half of 2019 remains in play. The quarterly level changes after the end of each quarter, so the close on Sep. 30 established the level for the fourth quarter. The close on Oct. 31 established the monthly level for November.
My theory is that nine years of volatility between closes are enough to assume that all possible bullish or bearish events for the stock are factored in. To capture share price volatility, investors should buy shares on weakness to a value level and reduce holdings on strength to a risky level. A pivot is a value level or risky level that was violated within its time horizon. Pivots act as magnets that have a high probability of being tested again before their time horizon expires.
How to use 12 x 3 x 3 weekly slow stochastic readings: My choice of using 12 x 3 x 3 weekly slow stochastic readings was based upon backtesting many methods of reading share-price momentum with the objective of finding the combination that resulted in the fewest false signals. I did this following the stock market crash of 1987, so I have been happy with the results for more than 30 years.
The stochastic reading covers the last 12 weeks of highs, lows, and closes for the stock. There is a raw calculation of the differences between the highest high and lowest low versus the closes. These levels are modified to a fast reading and a slow reading, and I found that the slow reading worked the best.
The stochastic reading scales between 00.00 and 100.00, with readings above 80.00 considered overbought and readings below 20.00 considered oversold. Recently, I noted that stocks tend to peak and decline 10% to 20% and more shortly after a reading rises above 90.00, so I call that an "inflating parabolic bubble," as a bubble always pops. I also refer to a reading below 10.00 as "too cheap to ignore."
Disclosure: The author has no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.