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 Hershey (NYSE: HSY ) 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 Hershey.
What We Want to See
Pass or Fail?
|Growth||5-year annual revenue growth > 15%||3.8%||Fail|
|1-year revenue growth > 12%||6.5%||Fail|
|Margins||Gross margin > 35%||42.9%||Pass|
|Net margin > 15%||9%||Fail|
|Balance sheet||Debt to equity < 50%||201.8%||Fail|
|Current ratio > 1.3||1.51||Pass|
|Opportunities||Return on equity > 15%||61.5%||Pass|
|Valuation||Normalized P/E < 20||22.40||Fail|
|Dividends||Current yield > 2%||2.4%||Pass|
|5-year dividend growth > 10%||6.4%||Fail|
|Total Score||4 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With just four points, Hershey doesn't paint a very sweet picture of its stock. The candymaker has faced some big headwinds lately from rising commodity prices, but Hershey seems to have higher costs under control for now.
As a well-known maker of chocolate and other candy, Hershey has to obtain huge amounts of raw materials to make its products. Just as other food-related companies, including Starbucks (Nasdaq: SBUX ) and McDonald's (NYSE: MCD ) , have had to raise their own retail prices in response to higher input costs, so too has Hershey seen unfavorable trends in the products it needs. In 2010, cocoa prices rose to levels near 30-year highs, and the company's costs for dairy products, sugar, peanuts, and almonds also rose. Although the company does its best to hedge costs using futures and forward contracts, long-run trends still eventually affect its profits.
From a financial standpoint, Hershey poses an interesting picture. It has far higher returns on equity than Kraft Foods (NYSE: KFT ) , which bought candymaker Cadbury last year , and Nestle. But that high ROE comes largely from the company's high leverage, with more than $1.8 billion in long-term debt.
Until Hershey gets that debt under control and its shares become more attractively priced, it isn't going to be a perfect stock. Yet with sufficient cash flow to cover interest payments as well as paying a dividend of more than 2%, investors with a sweet tooth for income might want to take a closer look.
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.