Walgreen stock: A pill that's not hard to swallow

— -- Q: What do you think about Walgreen stock wag?

A: When the economy slows, consumers can postpone or eliminate many expenses.

Plan for buying a new flat-screen TV, taking a Hawaiian vacation or even buying a new car can be easily dumped when times are tough. But people have a harder time going without medicine.

If that's true, why are shares of Walgreen down a bruising 36% this year? Should shares of the drug seller be holding up better since they sell necessities? After all, shares of drugmaker Pfizer are down less than 26%, which is better than the 36% loss suffered by the market at large.

The answer is that Walgreen doesn't just sell medicine. While prescription sales accounted for 65% of revenue last year, according to the company's annual report, 35% of sales come from the items in the store that may be more profitable than drugs.

Drugstores make a great deal of their profit from non-essentials, from candy and gum to beach umbrellas. In addition, they sell items like shampoo and cleaning supplies that may be priced more aggressively at big-box retailers like Wal-Mart. And in its most recent earnings report, Walgreen acknowledged consumers are focusing more on value and price.

With this in mind, are shares of Walgreen, selling near 52-week lows, a buy? Could the company's exposure to the relative safe haven of drug sales offer protection from a weak economy? To find out, we'll put the stock through the four steps considered at Ask Matt, including:

Step 1: Risk vs. reward. When you take a risk on a stock, you want to make sure you're properly rewarded. Downloading Walgreen's trading history back to 1980, we see the company generated an average annual compound rate of price appreciation of 16.7%. That's not even including the current dividend yield of 2%. This is a very high return since the S&P 500 posted an 11.6% return in the same time frame, says IFA.com.

But, here's the catch. To get the higher return you accepted higher risk — standard deviation — of 34.5 percentage points. That's much higher than the 14.9 percentage point risk of the S&P 500 during the period. So to get a 44% higher return you accepted 132% higher risk. That's not a great tradeoff and should stop many investors' analysis right there. But for you risk takers out there, keep reading.

Step 2: Measure the stock's discounted cash flow. Some investors decide if a stock is pricey by comparing its current price to the present value of its expected cash flows. It's a complicated analysis made simple with a system from NewConstructs. When we run Walgreen's stock, we find it's rated "attractive." In other words, thanks to the recent collapse in the stock price, the stock price is less than the company is expected to generate in cash over its lifetime. Using this analysis, it would appear Walgreen is worth a closer look.

Step 3: Compare the stock's current valuation to its historical range. BetterInvesting's Stock Selection Guide can help. If the company can increase earnings 14.5% a year the next five years, as analysts expect, that would put the stock in the "buy" range. That's a green light for investors who believe the price-to-earnings ratio will return to historical norms. Keep in mind, though, that 14.5% growth might be difficult given the tough economy.

Step 4: Check the company's financial health. Before investing in a company, you want to make sure it's in good financial shape. A quick way to check is to look at where it falls on the USA TODAY Stock Meter, which ranks stocks from conservative (1) to aggressive (5). Walgreen scores a solid 2.0 here. You can get a Stock Meter score for almost any stock by going to money.usatoday.com and putting the stock's ticker symbol or name into the Get a Quote box.

Walgreen also appears on the USA TODAY Readers' Choice list of stocks that appear most in readers' portfolios at USATODAY.com. It's current number 46 on the list.

The bottom line: While Walgreen's drug business is pretty stable, it has exposure to the retail market. That exposure is a large reason why the stock continues to suffer as investors brace for an economic slowdown. So far, the company has navigated well and will likely tweak stores to appeal to consumers looking for good prices.

If you're looking for a stable investment and are considering Walgreen, you might want to look for something less risky. But if you're looking to gamble on a company that has delivered in the past, and you are willing to endure higher risk in a volatile time, Walgreen stock is not a bad one to put on your shopping list.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns.