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 Bed Bath & Beyond (Nasdaq: BBBY ) 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 Bed Bath & Beyond.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||8.7%||Fail|
|1-Year Revenue Growth > 12%||13.2%||Pass|
|Margins||Gross Margin > 35%||41.2%||Pass|
|Net Margin > 15%||8.6%||Fail|
|Balance Sheet||Debt to Equity < 50%||0.0%||Pass|
|Current Ratio > 1.3||2.88||Pass|
|Opportunities||Return on Equity > 15%||20.4%||Pass|
|Valuation||Normalized P/E < 20||16.91||Pass|
|Dividends||Current Yield > 2%||0.0%||Fail|
|5-Year Dividend Growth > 10%||0.0%||Fail|
|Total Score||6 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With 6 points, Bed Bath & Beyond gets much of the way toward perfection. Even in a tough business, the home furnishings retailer has run a tight ship over the years in building its dominant position atop the industry.
Making money in home furnishings hasn't proven the easiest thing to do for many companies. Linens 'n Things went bankrupt in 2008, removing Bed Bath & Beyond's biggest competition. Pier 1 (NYSE: PIR ) has returned to profitability after a brush with near-bankruptcy, but even with huge performance in the past couple of years, shares still fetch less than half what they did in the early 2000s. And tiny Cost Plus (Nasdaq: CPWM ) isn't profitable, although shares have bounced sharply in the past year.
Through all this, though, Bed Bath & Beyond has maintained strong financial performance, and the recent rise in its stock price to new all-time highs is an indicator of that success. The company's net margins may not pass the perfect-stock test, but they're attractive for the cutthroat retail business. Moreover, generating 20%+ returns on equity without a penny of debt is a big accomplishment for any company.
Bed Bath & Beyond can't rest. As big-box retailers Wal-Mart (NYSE: WMT ) and Target (NYSE: TGT ) add home furnishings to their offerings, they'll increasingly butt up against Bed Bath & Beyond's turf. How the company handles that competition will go a long way toward deciding its future path.
Bed Bath & Beyond has done a great job in a tough business. If you think the recovering economy will eventually boost the housing market back toward normal, the home furnishing business may well bounce back even more strongly -- and that should only propel this industry leader.
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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