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 Smith & Wesson (Nasdaq: SWHC ) 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 Smith & Wesson.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||16.1%||Pass|
|1-Year Revenue Growth > 12%||26%||Pass|
|Margins||Gross Margin > 35%||29%||Fail|
|Net Margin > 15%||1.1%||Fail|
|Balance Sheet||Debt to Equity < 50%||52.9%||Fail|
|Current Ratio > 1.3||2.34||Pass|
|Opportunities||Return on Equity > 15%||(80.2%)||Fail|
|Valuation||Normalized P/E < 20||56.44||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With only three points, Smith & Wesson falls well short of hitting a bull's-eye. But lately, its soaring stock has made it an attractive target.
Smith & Wesson is well known for its firearms business. That business got hit hard in the recession, and as the fear of new gun-control laws has largely faded away, sales aren't getting a boost from those who think that it might be now or never for buying guns.
But Smith & Wesson also provides security services, and that part of the business hasn't performed all that well lately. Government cutbacks and lower corporate spending have held back sales, as ammunition makers Olin (NYSE: OLN ) and Alliant TechSystems (NYSE: ATK ) have seen in their businesses. Fortunately for Smith & Wesson, though, the segment is small enough that it doesn't make a huge difference to its bottom line.
Lately, demand for firearms has skyrocketed. Smith & Wesson reported strong earnings earlier this month, with a better-than-expected profit reversing a year-ago loss. The company also boosted its guidance for 2012. Then last week, Smith & Wesson shares soared again after Sturm Ruger (NYSE: RGR ) said that it was suspending new orders until May due to a huge backlog. That could give Smith & Wesson a chance to poach Sturm Ruger customers.
For Smith & Wesson to keep doing better, it needs to focus on its fundamentals and keep itself profitable. If current trends continue to favor firearms, then Smith & Wesson is in good position to get closer to hitting the target in the future.
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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