As the world's third-richest person and most celebrated investor, Warren Buffett attracts a lot of attention. Thousands try to glean what they can from his thinking processes and track his investments.
We can't know for sure whether Buffett is about to buy Rite Aid (NYSE: RAD ) -- he hasn't specifically mentioned anything about it to me -- but we can discover whether it's the sort of stock that might interest him. Answering that question could also reveal whether it's a stock that should interest us. In this series, we do just that.
Writing in a recent 10-K, Buffett lays out the qualities he looks for in an investment. In addition to adequate size, proven management, and a reasonable valuation, he demands:
- Consistent earnings power.
- Good returns on equity with limited or no debt.
- Management in place.
- Simple, non-techno-mumbo-jumbo businesses.
Does Rite Aid meet Buffett's standards?
1. Earnings power
Buffett is famous for betting on a sure thing. For that reason, he likes to see companies with demonstrated earnings stability.
Let's examine Rite Aid's earnings and free cash flow history:
Source: S&P Capital IQ.
Both Rite Aid's earnings and free cash flow have been almost all negative over the past five years.
2. Return on equity and debt
Return on equity is a great metric for measuring both management's effectiveness and the strength of a company's competitive advantage or disadvantage -- a classic Buffett consideration. When considering return on equity, it's important to make sure a company doesn't have an enormous debt burden, because that will skew your calculations and make the company look much more efficient than it is.
Since competitive strength is a comparison between peers, and various industries have different levels of profitability and require different levels of debt, it helps to use an industry context.
|
Company
|
Debt-to-Equity
|
Return on Equity
|
Return on Equity (5-year average)
|
| Rite Aid |
N/A |
N/A |
N/A |
| Walgreen (NYSE: WAG ) |
16% |
19% |
17% |
| CVS (NYSE: CVS ) |
26% |
9% |
10% |
| Express Scripts (Nasdaq: ESRX ) |
184% |
49% |
52% |
Source: S&P Capital IQ.
The pharmacy business is all over the map. CVS and Walgreen carry surprisingly little debt and generate somewhat low to substantial returns on equity, respectively. Although benefits manager Express Scripts carries a lot of debt relative to equity, its income from operations are high enough to comfortably pay off its interest, and it generates a reasonably return on equity -- even for so much debt. Unfortunately, Rite Aid actually has negative equity.
3. Management
CEO John Standley has been at the job since 2010. Before that he had been with the company in various other roles for a number of years.
4. Business
Pharmacies aren't particularly susceptible to technological disruption.
The Foolish conclusion
So is Rite Aid a Buffett stock? Probably not. Although the company has tenured management and operates in a technologically straightforward industry, it doesn't particularly exhibit some of the other quintessential characteristics of a Buffett investment: consistent earnings and high returns on equity with limited debt. However, you can stay up to speed on Rite Aid's progress by adding it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks by clicking here.
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