Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Lorillard (NYSE: LO ) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- 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 mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. 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 Lorillard.
What We Want to See
Pass or Fail?
|Growth||5-year annual revenue growth > 15%||7%||Fail|
|1-year revenue growth > 12%||10%||Fail|
|Margins||Gross margin > 35%||52.4%||Pass|
|Net margin > 15%||25.4%||Pass|
|Balance sheet||Debt to equity < 50%||NM||NM|
|Current ratio > 1.3||2.06||Pass|
|Opportunities||Return on equity > 15%||NM||NM|
|Valuation||Normalized P/E < 20||13.12||Pass|
|Dividends||Current yield > 2%||5.7%||Pass|
|5-year dividend growth > 10%||14.8%*||Pass|
|Total Score||6 out of 8|
Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful; Lorillard had negative shareholder equity in the period and therefore fails both tests. Total score = number of passes. *Growth rate since Lorillard started paying a dividend in 2008.
Lorillard comes up with a score of six. Despite a troubling balance sheet with negative equity, the tobacco maker's stock has seen some impressive gains since its 2008 spinoff from Loews (NYSE: L ) .
Lorillard isn't as well-known a name as rival Altria (NYSE: MO ) , but smokers are familiar with many of its brand names, which include Newport and Kent. The company has managed to squeeze plenty of profit from its sales, with net margins not only beating Altria's, but crushing those of Vector Group (NYSE: VGR ) and Reynolds American (NYSE: RAI ) .
On the other hand, Lorillard's balance sheet has some issues. Despite having more cash than long-term debt, Lorillard has negative shareholder equity, which makes returns on equity and debt-to-equity ratios meaningless. Still, the company's returns on assets and capital are very impressive.
Lorillard has faced controversy over its menthol cigarettes, which the Food and Drug Administration recently reviewed to see if they had greater health dangers than regular cigarettes. Last week, a draft FDA report suggested the answer was no, sending shares soaring.
As a domestic tobacco company, Lorillard will face constant pressure from health regulators and potentially major liability risk -- risk that in part motivated Altria's decision to spin off Philip Morris International (NYSE: PM ) in 2008. But Lorillard's dividend payouts are very high, and its valuation is reasonable even with the risk. Lorillard isn't perfect, but as long as it avoids major trouble, it should continue to produce attractive returns for investors.
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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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our 13 Steps to Investing Foolishly.