Is Rite Aid the Perfect Stock?

Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide whether Rite Aid (NYSE: RAD  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Rite Aid.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

8.6%

fail

 

1-year revenue growth > 12%

(2.5%)

fail

Margins

Gross margin > 35%

26.5%

fail

 

Net margin > 15%

(2.2%)

fail

Balance Sheet

Debt to equity < 50%

NM

fail

 

Current ratio > 1.3

1.9

pass

Opportunities

Return on equity > 15%

NM

fail

Valuation

Normalized P/E < 20

NM

fail

Dividends

Current yield > 2%

0%

fail

 

5-year dividend growth > 10%

0%

fail

 

Total Score

 

1 out of 10

Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful. Shareholder equity and normalized earnings were negative during the period. Total score = number of passes.

Rite Aid's score of 1 shows just how big a struggle the drug store retailer has had in recent years. Its main problem is debt, more than $6 billion of it, which is substantially greater than the company's $4.3 billion in total capital. In contrast, competitors Walgreen (NYSE: WAG  ) and CVS Caremark (NYSE: CVS  ) have much healthier balance sheets, with respectable debt-to-equity ratios of 0.17 and 0.33, respectively.

Few see any relief coming soon. Analysts expect losses to continue both this year and next. If today's low interest rates can't help Rite Aid solve its debt problems, it's unclear what will.

Granted, drug stores aren't known for their exciting growth; even emerging-market upstart China Nepstar (NYSE: NPD  ) has only single-digit revenue growth over the past three years. But investors looking for something other than a lottery ticket would do well to avoid Rite Aid shares unless the company can solve its long-term woes.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

The Motley Fool is recommending 50 stocks in 50 days for its new "11 O'Clock Stock" series. For more information, click here. Then come back to Fool.com every single weekday at 11 a.m. ET for a brand-new pick!

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 29, 2010, at 3:09 PM, gorlickg wrote:

    I have held this stock since 1999.

    Mr. Caplinger is right on with his analysis.

    This company has been in the I.C.U. for over 10 years now. Without any signs of recovery.

  • Report this Comment On September 29, 2010, at 3:57 PM, weiwentg wrote:

    I'm surprised that Rite Aid actually has two stars in CAPS - I think the firm is likely to go under. I don't short stocks, but if there were long dated put options, I'd buy them.

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