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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 AutoZone (NYSE: AZO ) fits the bill.
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 AutoZone.
What We Want to See
Pass or Fail?
|Growth||5-year annual revenue growth > 15%||6%||Fail|
|1-year revenue growth > 12%||10.2%||Fail|
|Margins||Gross margin > 35%||50.8%||Pass|
|Net margin > 15%||10.4%||Fail|
|Balance sheet||Debt to equity < 50%||NM||NM|
|Current ratio > 1.3||0.81||Fail|
|Opportunities||Return on equity > 15%||NM||NM|
|Valuation||Normalized P/E < 20||16.86||Pass|
|Dividends||Current yield > 2%||0%||Fail|
|5-year dividend growth > 10%||0%||Fail|
|Total Score||2 out of 8|
Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful because of negative shareholder equity. Total score = number of passes.
With only two points, AutoZone certainly doesn't seem to give you the parts you need for a healthy portfolio. But the stock has performed strongly as the slow economy has favored budget-minded consumers doing repairs to their older vehicles rather than buying new ones.
AutoZone is a rare example of a company that tends to do better when the economy is doing worse. A few years back during the depths of the last recession, new car sales from automakers Ford (NYSE: F ) and General Motors (NYSE: GM ) fell sharply. But since most people still need cars and older cars need maintenance work, auto-parts retailers such as Advance Auto Parts (NYSE: AAP ) , O'Reilly Automotive (Nasdaq: ORLY ) , and AutoZone reaped the benefit of the trend.
Even as the economy has improved, though, AutoZone's stock remains near its highs. The recent correction has again raised the specter of a double-dip recession, which could once again reawaken the vehicle-maintenance cycle and cause new car sales to slow.
AutoZone has had relatively healthy earnings over the past several years. The company's negative shareholder equity raises some concerns, although it stems largely from huge share buybacks that AutoZone uses to return cash to shareholders rather than through a dividend. Nevertheless, the company has funded those buybacks in part through increasing debt, which makes its balance sheet uglier than its peers'.
If the economy remains tough, then AutoZone could get another boost up from higher consumer demand. But if a true recovery takes hold, AutoZone might not look like a perfect stock for a while to come.
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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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our 13 Steps to Investing Foolishly.