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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 whether Fortune Brands (NYSE: FO ) 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 Fortune Brands.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||0.5%||fail|
|1-Year Revenue Growth > 12%||5.6%||fail|
|Margins||Gross Margin > 35%||43.9%||pass|
|Net Margin > 15%||6.3%||fail|
|Balance Sheet||Debt to Equity < 50%||77.2%||fail|
|Current Ratio > 1.3||2.06||pass|
|Opportunities||Return on Equity > 15%||7.8%||fail|
|Valuation||Normalized P/E < 20||25.26||fail|
|Dividends||Current Yield > 2%||1.2%||fail|
|5-Year Dividend Growth > 10%||(10.9%)||fail|
|Total Score||2 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of 2, it appears things couldn't get much further from perfect for Fortune Brands. But an encouraging recent move could finally be the beginning of the end of bad times at the company.
Fortune Brands is a conglomerate of diverse businesses, producing products ranging from Jim Beam bourbon to Titleist golf balls and Moen faucets. But being in all of those businesses means focusing on none of them, which has left the company at some competitive disadvantages. Unlike fellow spirits makers Diageo (NYSE: DEO ) and Brown-Forman (NYSE: BF-B ) , which have enjoyed strong returns on equity and steadily increasing dividends, Fortune had to cut its dividend last year in the aftermath of the financial crisis. Even worse, just as competitors Callaway Golf (NYSE: ELY ) and fixture maker Masco (NYSE: MAS ) have struggled, Fortune's golf and home businesses have seen big contractions in sales and profits from precrisis levels.
But interest from activist investor Bill Ackman and his Pershing Square hedge fund has helped renew hope for the company. Perhaps in response to Ackman's purchase of a stake in the company, Fortune announced yesterday that it would split itself into three companies. That move may help the market price the stock more easily, since comparisons with other single-line businesses will be simpler. And more importantly for investors, it will allow each company to focus on what it does best, potentially unlocking shareholder value in the process.
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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