Has Dollar General Become the Perfect Stock?

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.

Factor

What We Want to See

Actual

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.

Keep searching
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.

Dollar General isn't the perfect stock, but we've got some ideas you may like better. Let me invite you to learn about three smart long-term stock plays in the Fool's latest special report. It's yours for the taking and is absolutely free, but don't miss out -- click here and read it today.

Click here to add Dollar General to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Wal-Mart. Motley Fool newsletter services have recommended buying shares of Goldman Sachs and Wal-Mart, as well as creating a diagonal call position in Wal-Mart. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 03, 2012, at 4:26 PM, hurley11 wrote:

    Your statement that Family Dollar fell well short on sales expectations in its last quarter is false. You reference back to an early January article to support that claim. In fact, last Wednesday Family Dollar reported its most recent quarterly results and sales were not short of expectations. Further, with earnings exceeding expectations the stock price is up dramatically hitting new 52-week highs again today. Apparently, you do not follow the dollar store industry if in a story on retailers in that group you did not know Family Dollar reported its latest quarterly results, which have gotten a good deal of positive attention, a week ago. Perhaps you have some excuse for an apparent lack of diligence. If not one might suggest that your

    opinions on this retail segment lack credibility.

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