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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 Dollar Tree (Nasdaq: DLTR ) 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 Dollar Tree.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||11.6%||Fail|
|1-Year Revenue Growth > 12%||12.4%||Pass|
|Margins||Gross Margin > 35%||35.5%||Pass|
|Net Margin > 15%||6.8%||Fail|
|Balance Sheet||Debt to Equity < 50%||18.3%||Pass|
|Current Ratio > 1.3||2.50||Pass|
|Opportunities||Return on Equity > 15%||27.5%||Pass|
|Valuation||Normalized P/E < 20||16.41||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||6 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Dollar Tree weighs in with a score of 6. The company has done a good job of cashing in on the trend toward lower-end retail.
During the recession, discount retailers like Dollar Tree, Family Dollar (NYSE: FDO ) and Dollar General (NYSE: DG ) got lots of new business from financially stressed consumers looking for ways to stretch their budgets. That has led retail behemoths Wal-Mart (NYSE: WMT ) and Target (NYSE: TGT ) to try out smaller stores as a test to see if they can compete in the same store-size category as Dollar Tree and its peers.
Yet the surprising thing is that as the recession fades into the past, Dollar Tree and its competitors are still doing well. Yet with unemployment still high, discount retailers still have a wide base of potential customers to serve. Dollar Tree in particular just announced record sales and profits for its fourth quarter as well as full year 2010. A couple weeks ago, Family Dollar received a takeover bid at a big premium to where its shares were trading before the offer.
Unlike Family Dollar, Dollar Tree doesn't pay a dividend. But with comparable margins and returns on equity to Family Dollar that exceed those of Dollar General, Dollar Tree seems like just as strong a potential takeover target as Family Dollar. Even without a takeover, though, Dollar Tree has been in the right place at the right time and looks poised to build from its strong foundation going forward.
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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