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 Abercrombie & Fitch
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 Abercrombie & Fitch.
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Growth | 5-Year Annual Revenue Growth > 15% | 4.5% | Fail |
| 1-Year Revenue Growth > 12% | 18.4% | Pass | |
| Margins | Gross Margin > 35% | 63.8% | Pass |
| Net Margin > 15% | 4.3% | Fail | |
| Balance Sheet | Debt to Equity < 50% | 3.6% | Pass |
| Current Ratio > 1.3 | 2.56 | Pass | |
| Opportunities | Return on Equity > 15% | 8.1% | Fail |
| Valuation | Normalized P/E < 20 | 35.73 | Fail |
| Dividends | Current Yield > 2% | 1% | Fail |
| 5-Year Dividend Growth > 10% | 3.1% | Fail | |
| Total Score | 4 out of 10 |
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Abercrombie & Fitch wears a not-so-fashionable 4 as its score. The retailer has faced huge struggles for years, and although things may be looking up for the company, Abercrombie & Fitch still needs to convince skeptical investors who've gotten burned in the past.
Not so long ago, Abercrombie & Fitch was on top of the fashion world, performing well with its target teen audience. But the retailer got hit hard during the recession, as cash-strapped consumers couldn't afford its high price points and had to move down to competitors. For years, the company posted negative annual same-store sales and posted several months of consecutive double-digit drops in comps. In response, the company has done an aggressive cost-cutting campaign. Last year, it announced plans to cut 60 stores in 2010 and 50 more in 2011.
The retailer's moves seem to be bearing fruit. Earlier this month, Abercrombie boosted its guidance for 2012 well above what analysts were expecting, forecasting aggressive moves into international markets seeking to cash in on a global economic recovery. Meanwhile, the stock has run up substantially in hope for better earnings.
But competitors still have the upper hand. Buckle
Abercrombie may well recover from its long malaise. But with a pricey valuation, the stock isn't terribly compelling at these levels. It certainly doesn't resemble the perfect stock at the moment.
Keep searching
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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