Rite Aid's Sell-off Was Pointless, but Not a Reason to Buy

The third-place drugstore chain may have softer short-term earnings power than expected, but this doesn't have anything to do with operating business. The freshly discounted stock, though, is not a buy.

Jun 6, 2014 at 3:03PM

Drugstore chain Rite Aid (NYSE:RAD) was clobbered in Thursday's trading after the company reported that fiscal 2015 sales would be hindered by rising drug costs and that guidance was coming down by $0.02 on the top end and $0.01 on the bottom line. In isolation, the market reaction looks like a typical overreaction, and indicates that long-term investors could get in on the stock at a discounted price. Rite Aid has been in turnaround mode for the past couple of years, and the stock has skyrocketed well beyond its dirt cheap valuation in 2012. Does this week's discount give bargain-hunting investors another shot at the stock?

Short story
As an investor in Rite Aid stock, the fact that full-year earnings may come in a bit lower than previously expected is perhaps frustrating, especially if one recently bought the high-flying security. On the other hand, if one views themselves as a long-term part-owner of Rite Aid's business, the fact that drug prices will keep pressure on margins in the near term is of little to no concern for the ultimate success of the company.

The news simply does not affect the long-term value of the company, and says nothing about the operating business. Whether that implies that the shares are on sale is a different story.

A buy?
Rite Aid's return to the good graces of the market is a product of a few trends, mainly the recovery in the company's margins. With such slim operating and profit margins, Rite Aid can make tiny, incremental improvements in its pharmacy and front-of-store business and achieve tremendous gains on the bottom line of its income statement. Over the past several quarters, this has happened along with healthy gains in same-store sales. Management has rightfully focused on improving the store experience and competing more adeptly with the company's larger peers -- CVS Caremark and Walgreen. As a business, Rite Aid looks great and should continue to grow over the long-term with no problem.

The problem here is the market's irrational behavior, as usual. With its huge gain in capital appreciation comes a high hurdle to jump, as Rite Aid is valued at a trailing EV/EBITDA of more than 12 times and a forward P/E of 15.5 times. On the latter, the company is trading on par with CVS and cheaper than Walgreen. Beyond relative valuation, though, the company is priced to grow significantly. The lower-level margins can indeed appreciate quickly if Rite Aid is able to achieve similar margins to its major competitors, but right now that isn't the case. Investors are paying a significant premium for the business that isn't quite warranted, if price is considered paramount.

Rite Aid's business is fine and the market's sell-off over a cyclical event is irrelevant, but investors should not consider the sell-off an opportunity, as the price is still too high.

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend-paying counterparts over the long term. That’s beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor’s portfolio. To see our free report on these stocks, just click here now.

Michael Lewis has no position in any stocks mentioned. The Motley Fool recommends CVS Caremark. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.


Compare Brokers