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 Dollar Tree (Nasdaq: DLTR ) 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 Dollar Tree.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||10.8%||Fail|
|1-Year Revenue Growth > 12%||12.7%||Pass|
|Margins||Gross Margin > 35%||35.9%||Pass|
|Net Margin > 15%||7.4%||Fail|
|Balance Sheet||Debt to Equity < 50%||19.7%||Pass|
|Current Ratio > 1.3||2.08||Pass|
|Opportunities||Return on Equity > 15%||34.8%||Pass|
|Valuation||Normalized P/E < 20||23.03||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Dollar Tree last year, the company has lost a point. A huge run-up in share price has pushed earnings multiples to higher levels than we like to see, but longtime shareholders certainly haven't been complaining.
The trend in retail in recent years has been toward strength at both extremes of the market, in luxury retailers as well as deep-discount stores, versus weakness in mid-market retailers. Dollar Tree has certainly avoided the long series of same-store sales declines that Wal-Mart (NYSE: WMT ) went through, and even with Wal-Mart's recent revival, Dollar Tree still looks promising.
The reason is in margins. Deep-discount retail seems like it would inevitably be a low-margin business. But interestingly, Dollar Tree has seen huge margin expansion in recent years, already far exceeding the margins at higher-end discounters Costco (Nasdaq: COST ) and Wal-Mart. Lacking the volume that Wal-Mart and Costco have, Dollar Tree has found a profitable niche by choosing merchandise that it can mark up more while still holding true to its deep-discount customer base.
Another strength comes from groceries. Dollar Tree may not sound like the place to go for food, but its revenue growth has rivaled Whole Foods (Nasdaq: WFM ) while putting traditional grocer SUPERVALU (NYSE: SVU ) and its peers to shame. With smaller-size containers that maximize convenience for customers, Dollar Tree can get better profits on a per-unit basis.
For Dollar Tree to keep moving toward perfection, eventually it will have to find a way to start giving shareholders a bit of its profits through dividends. If it can keep earnings growing enough to finance a payout and keep its multiples lower, then Dollar Tree could see its score rise substantially in future years.
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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