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 Target (NYSE: TGT ) 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 areas, which 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 Target.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||5.6%||Fail|
|1-Year Revenue Growth > 12%||3.4%||Fail|
|Margins||Gross Margin > 35%||29.8%||Fail|
|Net Margin > 15%||4.2%||Fail|
|Balance Sheet||Debt to Equity < 50%||111.6%||Fail|
|Current Ratio > 1.3||1.56||Pass|
|Opportunities||Return on Equity > 15%||18.9%||Pass|
|Valuation||Normalized P/E < 20||14.57||Pass|
|Dividends||Current Yield > 2%||1.9%||Fail|
|5-Year Dividend Growth > 10%||18.5%||Pass|
|Total Score||4 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Target comes in with a score of just four points. The company has made some strides in keeping up with its big-box competitors, but it still falls short on a number of metrics.
For investors, Target stock has given investors powerful results lately. The shares are up more than 36% annually in the past two years, far outpacing Wal-Mart's (NYSE: WMT ) tepid 7% showing over the same period. That may result in part from the fact that Target has maintained higher margins than both Wal-Mart and Costco (Nasdaq: COST ) .
But competition in retail is fierce, and Target's growth rates leave something to be desired. Although the company looks better fundamentally than Sears Holdings (Nasdaq: SHLD ) , both Target's one-year and five-year revenue growth figures trail Wal-Mart and Costco. And although Target has an online presence, it pales in comparison to Amazon.com's (Nasdaq: AMZN ) dominance in the Internet retail space.
Target definitely has some appeal, with a dividend near 2% and a reasonable valuation. But before it can reach perfection, Target needs to demonstrate a clear advantage over its discount retail peers. Right now, it's unclear where the company will find that advantage.
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 Target to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.