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 PepsiCo (NYSE: PEP ) 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 PepsiCo.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||13.4%||Fail|
|1-Year Revenue Growth > 12%||10.9%||Fail|
|Margins||Gross Margin > 35%||52.2%||Pass|
|Net Margin > 15%||9.6%||Fail|
|Balance Sheet||Debt to Equity < 50%||120.7%||Fail|
|Current Ratio > 1.3||1.03||Fail|
|Opportunities||Return on Equity > 15%||27.7%||Pass|
|Valuation||Normalized P/E < 20||18.74||Pass|
|Dividends||Current Yield > 2%||3.1%||Pass|
|5-Year Dividend Growth > 10%||11.4%||Pass|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at PepsiCo last year, the company has dropped a point. Falling revenue growth explains the loss, but shareholders still have to be happy about a modest pickup in the share price over the past year.
The beverage industry has performed relatively well this year, despite some shared challenges. Like those of Coca-Cola (NYSE: KO ) and Dr Pepper Snapple (NYSE: DPS ) , PepsiCo's products include substantial amounts of high-fructose corn syrup, the price of which has soared recently as the price of corn has been very sensitive to this summer's drought conditions.
The key to success for PepsiCo has come from emerging markets. Soda consumption is down in North America, but with Pepsi's distribution systems forcing Starbucks (Nasdaq: SBUX ) to pay the company to distribute its Tazo teas rather than developing its own distribution network, PepsiCo has managed to reap benefits beyond its own business.
Moreover, many investors forget about the diversification advantages that PepsiCo's Frito-Lay snack unit gives the company. As the fight between Diamond Foods (Nasdaq: DMND ) and Kellogg over the Pringles brand last year shows, having a well-known snack line is very lucrative, and Frito-Lay has a more commanding presence over the snack market than Pepsi has against Coke and its peers.
For PepsiCo to improve, its plan to boost ad spending needs to produce much-needed revenue growth and better margins as well. With shares at the upper end of a reasonable valuation, though, PepsiCo may need to pause before it can make a real run toward perfection.
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 the best investments from the rest.
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