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 General (NYSE: DG ) 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 General.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||10.1%||Fail|
|1-Year Revenue Growth > 12%||13.6%||Pass|
|Margins||Gross Margin > 35%||31.7%||Fail|
|Net Margin > 15%||5.2%||Fail|
|Balance Sheet||Debt to Equity < 50%||56.3%||Fail|
|Current Ratio > 1.3||1.51||Pass|
|Opportunities||Return on Equity > 15%||17.6%||Pass|
|Valuation||Normalized P/E < 20||19.87||Pass|
|Dividends||Current Yield > 2%||0.0%||Fail|
|5-Year Dividend Growth > 10%||0.0%||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Dollar General last year, the company has doubled its score. Despite a supposedly rebounding economy, deep-discount retailers continue to hold their own, with favorable fundamentals leading to a big share-price gain for Dollar General stock.
Retail is a cutthroat business, but Dollar General has continued to perform well. With expanding margins and good sales growth, the company is making the most of the current economic environment. One interesting growth area is in groceries, where, along with Dollar Tree (Nasdaq: DLTR ) , Dollar General has tried to boost its food inventory in search of higher margins.
But weakness elsewhere in the sector has some wondering how long the good times will last. Family Dollar (NYSE: FDO ) fell well short of expectations on sales in its most recent quarter, suggesting that shoppers are finally turning to other stores. The recent reversal of Wal-Mart's (NYSE: WMT ) long string of same-store sales drops also supports the case that shoppers are moving back up-market in their focus.
Clearly, at least some investors think that Dollar General's stock has come too far too fast. The company did a secondary offering that gave private equity investors Goldman Sachs and KKR the chance to sell 25 million shares. After such a big run-up, it makes sense that investment firms would be looking for the exits, especially as shares remain fairly richly valued.
For Dollar General to keep improving, the next place it should focus is on getting its debt levels down somewhat. Expansion plans may make that difficult, but it's the most realistic way that Dollar General can hope to earn a higher score in the years ahead.
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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