Is Rite Aid Corporation Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Rite Aid Corporation (RAD -51.21%) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Rite Aid's story, and we'll be grading the quality of that story in several ways:

• Growth: Are profits, margins, and free cash flow all increasing?
• Valuation: Is share price growing in line with earnings per share?
• Opportunities: Is return on equity increasing while debt to equity declines?
• Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Rite Aid's key statistics:

RAD Total Return Price data by YCharts.

Source: YCharts. *Period begins at end of Q1 2011.

RAD Return on Equity (TTM) data by YCharts.

Source: YCharts. *Period begins at end of Q1 2011.

How we got here, and where we're going
Rite Aid's score has cratered since last year, as the pharmacy chain earns only two out of seven possible passing grades today, down from four in 2013. Rite Aid's net income growth has outpaced the gains in its free cash flow, but even a doubling of EPS in three years falls far short of the near-six-bagger returns Rite Aid investors have enjoyed -- virtually all of which has happened in the final two of those three years. Moreover, Rite Aid's negative return on equity and the massive debt on its balance sheet also continue to affect its performance. Rite Aid has been on the right track, but can it actually justify investor optimism with equally impressive fundamental growth in the coming quarters? Let's dig a little deeper to find out.

Rite Aid posted market-topping revenue and earnings per share in its fiscal fourth quarter despite the inclement weather that hammered much of the United States this past winter. The company also reported an impressive 5% increase in same-store sales for the month of April, although this seems to be due largely to the timing of Easter celebrations this year. Ride Aid also made a surprise move to acquire RediClinic, an operator of 30 retail mini-clinics in several Texan cities, and it now plans to grow the clinic by another 70 locations by the end of 2015. Rite Aid and its peers should also continue to benefit from higher-margin generic drug sales, as pharmaceutical companies are in the process of falling off a patent cliff, losing patent protections on drugs accounting for $123 billion in global sales between 2012 and 2017.

Rite Aid's shares have already rallied more than 50% this year as the company continues to implement its strategic growth plan, which emphasizes closing unprofitable stores while remodeling and relocating more viable ones, which has allowed it to dramatically improve its fundamentals over the past few years. Rite Aid seems to deserve a better valuation than it now boasts relative to larger peers Walgreen (WBA -1.40%) and CVS Caremark (CVS -1.03%) -- Rite Aid currently trades at a low 0.3 price-to-sales ratio, compared to Walgreen's 0.9 and CVS Caremark's 0.7 price-to-sales ratios. However, weaker profit margins than its fellow pharmacy chains likely hold Rite Aid back from this higher valuation, as you'll see below:

RAD PS Ratio (TTM) data by YCharts.

Fool writer Andres Cardenal points out that Rite Aid has converted more than 1,200 stores to its updated "wellness" format, and will close in on 1,600 remodeled stores by the end of the year. Rite Aid has also enrolled over 1.7 million elderly consumers in its Wellness 65+ loyalty program, which cleverly targets the segment of the populace most dependent on pharmacy sales and services. Rite Aid has also expanded its generic-drug sourcing and distribution agreement as part of McKesson's (MKC -0.66%) One Stop proprietary generics program, which should reduce purchasing costs and working capital needs by $150 million over the next fiscal year. That's no small accomplishment, as $150 million is a full 60% of Rite Aid's trailing-12-month profit. However, Walgreen's sourcing partnership with AmerisourceBergen offers a vast network of 170,000 distribution points, and its acquisitions of USA Drug and Kerr Drug last year further enhance its reach. Meanwhile, CVS continues to expand its in-store MinuteClinic franchises, which currently add up to more than 800 locations in the U.S.

Putting the pieces together
Today, Rite Aid has few of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.