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 Coach (NYSE: COH ) 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 Coach.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||14.1%||Fail|
|1-Year Revenue Growth > 12%||13.2%||Pass|
|Margins||Gross Margin > 35%||72.3%||Pass|
|Net Margin > 15%||21.2%||Pass|
|Balance Sheet||Debt to Equity < 50%||1.3%||Pass|
|Current Ratio > 1.3||2.34||Pass|
|Opportunities||Return on Equity > 15%||52.7%||Pass|
|Valuation||Normalized P/E < 20||25.28||Fail|
|Dividends||Current Yield > 2%||1.2%||Fail|
|5-Year Dividend Growth > 10%||NM||NM|
|Total Score||6 out of 9|
Source: S&P Capital IQ. NM = not meaningful; Coach has only paid a dividend since 2009. Total score = number of passes.
Since we looked at Coach last year, the company has lost a point. A slowdown in the high-end retailer's long-term sales growth may be cause for concern, but Coach has plenty of growth opportunities left.
Retail is typically a low-margin business. But Coach has consistently found a path to generating strong margins, with a healthy balance sheet and strong cash flow to boot. Cashing in on the potential for international growth, Coach has made several moves to bolster its global presence, taking control of retail outlets in certain parts of Asia and expanding with new stores in Europe.
One trend that Coach has seen lately is that shoppers are choosing accessories over clothing purchases. That bodes well not just for Coach but also for Tiffany (NYSE: TIF ) and Michael Kors (NYSE: KORS ) as well. In fact, Tiffany and Kors may do better than Coach, because Tiffany aims very high on its price points and Kors has both high-end and low-end collections, while Coach sticks mostly at the lower end of the accessories market.
One area where Coach needs to improve is in its dividend payout. Luxury-oriented peers Williams-Sonoma (NYSE: WSM ) and Nordstrom (NYSE: JWN ) both pay higher dividend yields despite having similar demands on capital for internal investment. One could argue, though, that Coach is seeking to expand faster than either Nordstrom or Williams-Sonoma, and so spending more now to make more later is a smart move.
In the end, the overall global economy will play a huge role in Coach's success. If growth in emerging markets continues, Coach will be right there to take advantage of it.
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 the best investments from the rest.
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