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 Limited Brands (NYSE: LTD ) 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 Limited Brands.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(0.6%)||Fail|
|1-Year Revenue Growth > 12%||7.8%||Fail|
|Margins||Gross Margin > 35%||44.6%||Pass|
|Net Margin > 15%||8.2%||Fail|
|Balance Sheet||Debt to Equity < 50%||2,607.0%||Fail|
|Current Ratio > 1.3||1.55||Pass|
|Opportunities||Return on Equity > 15%||105.3%||Pass|
|Valuation||Normalized P/E < 20||19.02||Pass|
|Dividends||Current Yield > 2%||2.1%||Pass|
|5-Year Dividend Growth > 10%||10.8%||Pass|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Limited Brands last year, the company has seen its score rise by a point. A higher dividend has helped send shares soaring over the past year.
The retail industry is one of the clearest examples of a sector with obvious winners and losers. On one hand, companies like Limited and lululemon athletica (Nasdaq: LULU ) have been able to increase their margins even in a challenging holiday season that saw significant discounting from many players. On the other, American Eagle Outfitters (NYSE: AEO ) and Aeropostale (NYSE: ARO ) have gotten hurt a lot more from high cotton costs that they proved unable to pass on to customers late last year.
Lately, Limited has benefited from favorably warm winter weather. The company reported 8% same-store sales jumps in both February and March, joining a host of other retailers that beat expectations, but weighing in ahead of most. Only TJX (NYSE: TJX ) and its TJ Maxx line of stores was able to come in with higher sales in February.
But debt remains a big concern at Limited. Although minuscule shareholder equity inflates the debt-to-equity ratio somewhat, the company still has about $3.6 billion in debt on its balance sheet. Yet the company has also been paying special dividends lately, raising questions about why Limited doesn't use spare cash to pay down debt.
For Limited to keep improving, getting the balance sheet in better shape should be a top priority. With CEO Les Wexner owning more than 16% of the company, shareholders have management in their corner to support continued initiatives to boost the share price going forward.
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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