Lessons From Rite Aid

 | Apr 10, 2014 | 2:30 PM EDT
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Remember Rite Aid (RAD)? Over the past several years, it had become the red-headed stepchild of the retail pharmacy group, which also includes CVS Caremark (CVS) and Walgreen (WAG). Rite Aid is still a distant third behind those two convenience drugstore chains.

But Rite Aid offers a lesson in why investing during times of pessimism can yield a big payoff. For six years prior to 2013, Rite Aid was mired in leverage and operating losses. Two years ago, the shares were trading for $1.50. In 2013, Rite Aid reported its first profit in six years. This morning, Rite Aid announced another profitable quarter, its sixth consecutive quarter of profitability. In addition, Rite Aid announced an acquisition of a small drugstore retail chain in Texas that it plans to expend.

Today, Rite Aid's shares trade for over $7, having delivered a near 400% return in two years. Shares advanced more than 270% in 2013. Now demand for shares is swelling as investors chase the optimism.

Warren Buffett said it best: "Be greedy when others are fearful and fearful when others are greedy."

Stocks that are baking in a lot of fear and pessimism always warrant a closer look. You could have the next Rite Aid on your hands. Of course, you could also have the next Circuit City, which was forced to file for bankruptcy amid unbeatable pressure from Best Buy (BBY) and Wal-Mart (WMT).

Currently, I'm creating a basket of these pessimism-laden securities and monitoring them. The basket concept is a valid one, because if your basket contains one Rite Aid, you can have two Circuit Cities and still do very well. So far, I'm looking at J.C. Penney (JCP), RadioShack (RSH), Weight Watchers (WTW) and Blyth (BTH). All four of these names are hated today by Mr. Market, and he is a very optimistic fellow these days. So enamored with the highfliers of today is Mr. Market that he may be leaving some gold nuggets in the dust. So far this year, these four securities have returned -1%, -18%, -33% and -11%, respectively.

Why would anyone want to own these "losers" when the market is on a roll? I believe that Rite Aid answers that question. The opportunity is there. You just have to be diligent and patient and intelligently diversify your way into a very respectable capital gain.

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