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 Lorillard (NYSE: LO ) 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 Lorillard.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||7.8%||Fail|
|1-Year Revenue Growth > 12%||9.8%||Fail|
|Margins||Gross Margin > 35%||52.6%||Pass|
|Net Margin > 15%||25.1%||Pass|
|Balance Sheet||Debt to Equity < 50%||NM||NM|
|Current Ratio > 1.3||1.73||Pass|
|Opportunities||Return on Equity > 15%||NM||NM|
|Valuation||Normalized P/E < 20||15.39||Pass|
|Dividends||Current Yield > 2%||4.7%||Pass|
|5-Year Dividend Growth > 10%||16.1%*||Pass|
|Total Score||6 out of 8|
Source: S&P Capital IQ. NM = not meaningful due to negative shareholder equity. Total score = number of passes. *Three-and-a-half-year growth rate.
Since we looked at Lorillard last year, the company has kept its six-point score. The tobacco industry continues to survive regulatory attacks, but Lorillard is actually holding up better than some of its peers.
Lorillard has posted some impressive growth lately. In its most recent quarter, the company managed to push earnings up 26% from last year's levels, crushing estimates. In response, Lorillard boosted its dividend by 19%.
But the cigarette industry has had to fight regulatory initiatives lately. Reynolds American (NYSE: RAI ) and Lorillard sued the FDA to stop proposed regulations that would have required huge warning labels on cigarettes. A court ruling struck down the regulation as an infringement on free speech, but the FDA is likely to keep trying for similar rules in the future. That's one major reason why investors look to Philip Morris International (NYSE: PM ) as a way to escape U.S. regulation, although internationally, other governments are also taking similar measures.
Moreover, most tobacco companies are seeing big problems. Altria (NYSE: MO ) and Vector Group (NYSE: VGR ) have seen drops in sales volume, and Reynolds American and Altria have announced job cut plans in order to reduce costs. By contrast, Lorillard has boosted sales.
For Lorillard to keep improving, the first step will be to get its shareholder equity above the zero mark. Unfortunately, that measure has gotten a lot worse in the past year, as the company gets further into debt. Until it gets its finances under control, Lorillard won't be able to get those final few points toward perfection.
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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