Rite Aid stock revisited; still in need of some medicine
— -- Q: What do you think of Rite Aid stock (RAD)?
A: Investors are starting to move from trying to pick companies that can survive the recession, to those that can thrive.
Though March, investors closely monitored companies' balance sheets. They wanted to make sure companies had enough cash to just stay in business. And they were wary of companies that loaded up on debt during the borrowing boom.
Such worries about the financial standing of drugstore chain Rite Aid were addressed here.
Now, investors seem to be moving from worrying about companies' financial health to trying to gauge their profit potential and future growth. That's a much different calculation.
Rite Aid is a popular topic for Ask Matt questions. I've written about the stock several times, usually concluding investors should look elsewhere. You can read my most recent assessment here.
Since there's still interest, I'll put Rite Aid once more through the four financial tests we use to evaluate stocks:
Step 1: Risk vs. reward. When you take a risk on a stock, you want to make sure you're properly rewarded. Downloading Rite Aid's trading history back to 1980, we see the company generated an average annual compound rate of price appreciation of 18.5%. This is a high return; the S&P 500 posted a 10.4% annual return in the same time frame, says IFA.com.
But here's the rub: If you owned Rite Aid, you accepted higher risk — standard deviation — of 66 percentage points. That's much higher than the 15.5 percentage point risk of the S&P 500 during the period. So to get a 78% higher return you accepted 326% higher risk. That's not a great tradeoff and should stop many potential investors right there.
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 I run Rite Aid's stock, I find it's rated "dangerous." In other words, the stock is expensive relative to the cash the company is expected to generate over its lifetime.
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 7.5% a year the next five years, as analysts expect, that would still put the stock in the "sell" range. That's a red light for investors who believe the price-to-earnings ratio will return to historical norms.
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). Rite Aid scores an aggressive 4.2 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.
Bottom line:It may be tempting to take a chance on Rite Aid. The company is a household name in a business segment that should benefit from the aging population. And as previously discussed, the company has a decent pile of cash to keep it going. But a company's ability to merely survive isn't what makes a good investment. You might want to keep looking, and see if you can find a less risky place to put your money.
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. Follow Matt on Twitter at: twitter.com/mattkrantz