Is Rite Aid a Buffett Stock?

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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 (NYS: 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 his most 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:

  1. Consistent earnings power.
  2. Good returns on equity with limited or no debt.
  3. Management in place.
  4. 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 history:

anImage

Source: S&P Capital IQ.

Over the past five years, Rite Aid has had a difficult time generating earnings.

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 Ratio

Return on Equity

5-Year Average Return on Equity

Rite AidN/AN/AN/A
CVS (NYS: CVS) 29%9%12%
Walgreen (NYS: WAG) 16%19%17%
Express Scripts (NAS: ESRX) 224%47%52%

Source: S&P Capital IQ. N/A = not applicable.

Rite Aid doesn't have a return on equity or a debt-to-equity ratio because it has negative equity --generally not a good sign. Most recently, it had $6.2 billion in debt and $0.50 out of every dollar in operating income went toward paying interest.

3. Management
CEO John Standley has been at the job for about a year. Prior to that, he served as Rite Aid's CFO and the CEO of a supermarket chain.

4. Business
Drugstores aren't particularly susceptible to technological disruption.

The Foolish conclusion
Regardless of whether Buffett would ever buy Rite Aid, we've learned that, though it operates in a straightforward industry, it doesn't particularly exhibit the other characteristics of a quintessential Buffett investment: stable earnings, high returns on equity with limited debt, and tenured management.

That being said, if you'd like to stay up to speed on the top news and analysis on Rite Aid to monitor the company's attempted turnaround, simply add it to your stock watchlist. If you don't have one yet, you can create a watchlist of your favorite stocks here.

At the time this article was published Ilan Moscovitzdoesn't own shares of any company mentioned.You can follow him on Twitter@TMFDada. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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