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 Gap (NYSE: GPS ) 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 Gap.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(1.6%)||Fail|
|1-Year Revenue Growth > 12%||0.6%||Fail|
|Margins||Gross Margin > 35%||37.9%||Pass|
|Net Margin > 15%||6.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||62.4%||Fail|
|Current Ratio > 1.3||1.83||Pass|
|Opportunities||Return on Equity > 15%||28.0%||Pass|
|Valuation||Normalized P/E < 20||9.88||Pass|
|Dividends||Current Yield > 2%||2.4%||Pass|
|5-Year Dividend Growth > 10%||8.9%||Fail|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Gap last year, the clothing retailer has fallen by one point. The company has taken on a substantial amount of long-term debt over the past year, explaining the move from six points to five.
Gap has had a hard time over the past several years. Numerous rounds of cost-cutting have helped it survive a long-term trend toward falling revenue, but such measures can't reverse the loss of interest in what many perceive as stale fashion concepts.
In response, Gap is aggressively cutting back on its store count, closing more than a third of its U.S. stores between now and the end of 2013. Gap isn't alone in doing so; competitor Abercrombie & Fitch (NYSE: ANF ) and home-improvement retailer Lowe's (NYSE: LOW ) have planned to close some stores as well. But Gap stands out for its continuing drops in same-store sales, in stark contrast to rivals including Limited Brands (NYSE: LTD ) , The Buckle (NYSE: BKE ) , and Zumiez (Nasdaq: ZUMZ ) -- all of which posted decent gains in October comps.
One area where Gap stands out, though, is in social responsibility. It scored high marks for management remaining accountable for issues like labor practices. But all the accountability in the world can't change the fact that the company hasn't been able to recover from its doldrums.
To start moving in the right direction again, Gap needs a complete fashion makeover. Only by washing itself of its unfashionable reputation can Gap hope to get back in the good graces of its customers -- and thereby get its stock back on track toward perfection.
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."