The Fallacy of Absolute Returns

Bloomberg has a nice article today talking about how the Tiger Cubs are kicking butt. It was interesting but irked me because it touched on a hot button topic for me - CVS. As most of you know, I trashed the merger between CVS and Caremark, a stance I still hold. Given CVS has climbed over 22% since the start of 2007, how can I diss the merger? Simple, the merged company derives 50% of its revenues from the PBM business and 50% from retail drug operations. If you replicated this exposure by buying equal weights of one of the two other leading PBMs (MHS or ESRX) and WAG (not just a dog but a dead dog) you nicely outperformed CVS - 18 percentage points with ESRX and 14 percentage points with MHS. When viewed like this, CVS horribly underperformed.

I have no idea which will do better going forward. I no longer follow the PBMs and WAG's hubris is catching up with it (and consumer exposure) so perhaps CVS will outperform this its alternatives over the next 12-18 months. However, anyone bragging about their performance because they bought CVS due to the "merger synergies" is either clueless or passing on spin.

On a further note, I do think this pair trade opportunity is one I might seek to employ going forward. Find a sketchy merger, short the merger and recreate the economic exposure by purchasing the peers. I only have one other datapoint (BSX vs. its peers following the GDT acquisition) so it is worthy of some skepticism. However, most of the studies of mergers suggest they underperform following the deal so I think it has some legitimacy. Nominations for employing this strategy are welcomed...