Is Kraft Foods the Perfect Stock?

Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide whether Kraft Foods (NYSE: KFT  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Kraft.

Factor What We Want to See Actual Pass or Fail?
Growth 5-Year Annual Revenue Growth > 15% 6.6% fail
  1-Year Revenue Growth > 12% 13.4% pass
Margins Gross Margin > 35% 37.1% pass
  Net Margin > 15% 9.6% fail
Balance Sheet Debt to Equity < 50% 90.6% fail
  Current Ratio > 1.3 1.11 fail
Opportunities Return on Equity > 15% 9.8% fail
Valuation Normalized P/E < 20 16.55 pass
Dividends Current Yield > 2% 3.7% pass
  5-Year Dividend Growth > 10% 7.2% fail
       
  Total Score   4 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

Kraft's score of 4 doesn't reflect its dominant status within the food industry. Kraft was part of Altria (NYSE: MO  ) until the cigarette giant did an initial public offering of Kraft shares back in 2001, and spun off the rest of its holdings of the food company in 2007. By freeing Kraft's assets from potential liability from tobacco lawsuits, the separation from Altria added value for shareholders.

Looking at Kraft's financials, you'll see many of the same pros and cons as food-services company Sysco (NYSE: SYY  ) and ketchup king Heinz (NYSE: HNZ  ) . The industry doesn't sport fast growth or high net margins, but it's a cash cow for its leaders. Kraft is neither extremely cheap nor obviously overpriced, and its dividend is healthy but not outrageous. Kraft had raised its payout every year since its IPO.

Kraft falls short only in free cash flow, which hampers its ability to pay down debt and threatens its balance sheet. Both Kellogg (NYSE: K  ) and General Mills (NYSE: GIS  ) do a consistently better job producing cash flow from total revenue. But with a strong brand and plenty of consumer awareness, Kraft has the potential to get a lot closer to perfection than it is today.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Add Kraft Foods to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Sysco is a Motley Fool Inside Value recommendation. H.J. Heinz, Kellogg, and Sysco are Motley Fool Income Investor recommendations. The Fool owns shares of Altria Group and Sysco. Try any of our Foolish newsletter services free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 22, 2010, at 12:23 PM, PeyDaFool wrote:

    Hey Dan,

    It might also be interesting to add "outperformed the S&P 500" as one of your criterion for "the perfect stock."

    Despite only receiving a 4/10 for your metric, KFT has returned a positive alpha of about 10% of SPY over the past year, roughly 8% over the past six months and about by about 6% since the IPO spinoff from MO.

    I own shares of KFT and have been very happy with the performance and the dividend payouts. As you mentioned, the higher level of debt is a bit disconcerting, but is this not a reflection of the recent Cadbury acquisition?

  • Report this Comment On October 22, 2010, at 4:59 PM, TMFGalagan wrote:

    @PeyDaFool -

    It's an interesting idea to add past stock performance as a gauge, but you'd run into some heated debate between value and momentum investors about whether outperforming or underperforming was what earned you the point.

    Kraft's debt started rising in 2007, when it acquired Danone's cookie business. If the acquisitions eventually help it improve cash flow, then I suspect it will get that debt better under control.

    best,

    dan (TMF Galagan)

  • Report this Comment On October 25, 2010, at 11:27 AM, juanchoc wrote:

    Yup. There's no beating Cadbury

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