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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 if Ross Stores (Nasdaq: ROST ) 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 Ross Stores.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||10.2%||Fail|
|1-Year Revenue Growth > 12%||11%||Fail|
|Margins||Gross Margin > 35%||26.9%||Fail|
|Net Margin > 15%||7%||Fail|
|Balance Sheet||Debt to Equity < 50%||11.7%||Pass|
|Current Ratio > 1.3||1.53||Pass|
|Opportunities||Return on Equity > 15%||44.8%||Pass|
|Valuation||Normalized P/E < 20||14.30||Pass|
|Dividends||Current Yield > 2%||1%||Fail|
|5-Year Dividend Growth > 10%||25%||Pass|
|Total Score||5 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of 5, Ross Stores appears in the middle of the pack. But given how hard it is for low-margin retailers to earn high scores on this scale, Ross does a good job with what it has.
One of the most interesting areas in retail is so-called off-price retail. The recession has only emphasized the fact that bargain-hungry shoppers are more value conscious than ever, but they also want the brand names they know and love. That's awakened interest both in online website Overstock.com (Nasdaq: OSTK ) as well as brick-and-mortar stores from companies like Big Lots (NYSE: BIG ) and DSW (NYSE: DSW ) .
As fellow Fools Dayana Yochim and Alyce Lomax recently discovered, Ross and TJX (NYSE: TJX ) are in a class by themselves in this niche. Their returns on equity are double those of Big Lots and DSW, even without using the extensive leverage that Overstock.com has used to generate high ROE. And despite the fact that retail net margins are inevitably low, Ross scores above those of its competitors, including TJX.
Most interestingly, Ross has indicated a commitment to shareholders by paying a dividend. Although a 1% yield isn't all that high, the company's dividend growth in recent years suggests that number could rise over time.
Ross isn't the perfect stock, but it's identified an interesting retail segment that holds promise for the future. Even as the economy improves, bargains will never go out of style, and there'll always be a place for stores like Ross.
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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