Is Cherokee 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 if Cherokee (Nasdaq: CHKE  ) 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 Cherokee.

Factor What We Want to See Actual Pass or Fail?
Growth 5-year annual revenue growth > 15% (5.6%) Fail
  1-year revenue growth > 12% (0.5%) Fail
Margins Gross margin > 35% 100% Pass
  Net margin > 15% 34.8% Pass
Balance sheet Debt to equity < 50% 0% Pass
  Current ratio > 1.3 2.50 Pass
Opportunities Return on equity > 15% 56.7% Pass
Valuation Normalized P/E < 20 14.73 Pass
Dividends Current yield > 2% 7.8% Pass
  5-year dividend growth > 10% (5.3%) Fail
       
  Total Score   7 out of 10

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

With seven points, Cherokee looks pretty good. Much of its success comes from its unusual business model, which milks value from brand names without having to actually manufacture any products.

What Cherokee does is to act as a go-between for brand owners and retailers. Cherokee licenses brand-name rights to major retailers, which are then responsible for manufacturing and marketing products. Target (NYSE: TGT  ) is the company's main partner and is responsible for more than 40% of Cherokee's sales, but it also has arrangements with TJX (NYSE: TJX  ) and Brazil's Grupo Pao de Acucar (NYSE: CBD  ) .

Unfortunately, Cherokee got hit hard by the recession. Revenue fell sharply, and even though its current return on equity of 56% looks attractive, it was actually much higher in previous years. After years of dividend hikes, the company had to rein in payouts.

As the economy recovers, though, Cherokee could return to its winning ways. Compared with competitor Iconix Brand Group (Nasdaq: ICON  ) , Cherokee has a pristine balance sheet and much higher returns on equity, and Iconix doesn't pay a dividend . If you want a play on retail without the hassle of retail overhead, Cherokee might well be the perfect stock for you.

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.

Click here to add Cherokee to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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