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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 if Diageo (NYSE: DEO ) 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 Diageo.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||7.9%||fail|
|1-Year Revenue Growth > 12%||5%||fail|
|Margins||Gross Margin > 35%||58.1%||pass|
|Net Margin > 15%||16.7%||pass|
|Balance Sheet||Debt to Equity < 50%||220.2%||fail|
|Current Ratio > 1.3||1.76||pass|
|Opportunities||Return on Equity > 15%||45.9%||pass|
|Valuation||Normalized P/E < 20||18.89||pass|
|Dividends||Current Yield > 2%||3.3%||pass|
|5-Year Dividend Growth > 10%||5.2%||fail|
|Total Score||6 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of 6, Diageo may not be perfect. But as the leader in the worldwide spirits industry, Diageo definitely merits a closer look.
So-called sin stocks have made strong investments for a long time, through good times and bad. Whether you prefer Diageo's spirits, Altria's (NYSE: MO ) tobacco, or beer from Molson Coors (NYSE: TAP ) , stocks that enjoy constant demand for their products have done quite well over the past two years. With brands including Johnnie Walker and Guinness, Diageo has turned its emphasis on premium brand-building into a profit-making machine that puts competitor Fortune Brands (NYSE: FO ) and its weaker growth and margins to shame.
Still, Diageo isn't top-of-class in every aspect. Brown-Forman (NYSE: BF-B ) has somewhat better margins and a correspondingly healthier balance sheet, although it has grown at a slower rate than Diageo has and pays a smaller dividend.
Diageo gives investors a solid quarterly payout as well as the prospect for future growth as globalization continues to bring new markets to the spirit-maker. Like a great mixed drink, that's a combination that should make everyone a little happier.
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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