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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.
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.
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