July 2nd, 2007
Dear Jim Cramer,
So, your preference for Walgreen over Rite Aid in mid-2005 may have been justified on fundamental grounds but the question remains which might have been the better choice based on charts. What would RAD’s chart as of June 30, 2005 looked like and what would action, if any should have been taken:
RAD presents a dramatically different picture than WAG (see prior posting). Over the previous 5-6 years, Rite Aid was struggling with state and federal suits against management fraud, overly aggressive drug marketing and one of the largest financial restatements in history. By June, 2005, when you made your comparison, RAD was attempting to right itself with new management and new marketing programs.
Obviously, it would have been irresponsible and a violation of fiduciary responsibilities for institutions to invest in RAD but, for individual investors, this could have been an opportunity to take a risky gamble on a turnaround situation.
When a stock falls as much as RAD did after 1999 and hovers so close to $0, most price action can be interpreted as a bottom. No decision should be made until there’s a clear signal of a “rebirth” (in the parlance of Life Cycle Investing) and the likelihood of subsequent development and growth.
As the above chart indicates, RAD was in the process of forming a triangle bottom … a very unreliable bottom pattern formation. A purchase might be indicated if there were a breakthrough of the upper-boundary of the pattern on high volume. Actually, a more prudent decision would be to wait until the stock rebounded above a secondary resistance trendline above a previous high pivot point as indicated with the dashed line.
As I wrote earlier, RAD has gone up nearly 50% since mid-2005, clearly the better of the choice between RAD and WAG. It is now at the a secondary resistance trendline and, if successfully breached with volume, the move could continue to above 9, nearly a 100% move since 2005.
Someone following charting disciplines might have taken a gamble on the break out from the triangle. Even at this point, after successfully negotiating this resistance trendline, a commitment could be made.
Finally, with all the fundamental changes that have taken place at Rite Aid over the past 5 years, RAD may be a “reborn” stock, one that is evolving out of its development phase and entering a new growth phase that could last several years and carry the stock over that time to its previous all-time high above 35.
There’s nothing to say that as a fundamental analyst you might not have come back around to looking RAD again and gotten a much different valuation than you did in 2005. And then, again, you might still decide that it’s more than fairly valued, perhaps even “over-valued”. And in the meantime, you’ve missed the opportunity of making 50%, even 100%.