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 Pep Boys (NYSE: PBY ) 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 Pep Boys.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(1.7%)||Fail|
|1-Year Revenue Growth > 12%||3.8%||Fail|
|Margins||Gross Margin > 35%||24.7%||Fail|
|Net Margin > 15%||1.4%||Fail|
|Balance Sheet||Debt to Equity < 50%||58.5%||Fail|
|Current Ratio > 1.3||1.27||Fail|
|Opportunities||Return on Equity > 15%||5.9%||Fail|
|Valuation||Normalized P/E < 20||30.83||Fail|
|Dividends||Current Yield > 2%||0.8%||Fail|
|5-Year Dividend Growth > 10%||(15.0%)||Fail|
|Total Score||0 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Pep Boys doesn't manage to score a single point on our checklist. Yet the company attracted the attention of a private equity firm that clearly believes in its potential.
Pep Boys is a retailer selling auto parts and repair services. That's been a great place to be in recent years, as cash-strapped consumers are holding onto their cars for record-long periods of time. The average car in the U.S. is now more than a decade old. Parts giants AutoZone (NYSE: AZO ) and Advance Auto Parts (NYSE: AAP ) have turned that trend into growing revenue, as customers need more parts to keep their vehicles running longer. AutoZone turned in double-digit earnings growth for the 13th straight quarter last month, while Advance and O'Reilly Automotive (Nasdaq: ORLY ) both recorded strong fourth-quarter profits that continued years-long trends. Even upstream parts-maker Genuine Parts (NYSE: GPC ) showed a record rise in revenue along with fast earnings growth for the second year in a row.
The strength in the industry explains why the Gores Group decided to make an offer back in January to buy out Pep Boys for more than $800 million. The shares now trade for just pennies below the $15 per share offering price, suggesting that investors believe the deal will go through without a competing offer creating a bidding war. Shareholders may feel fortunate that the bid is on the table, as its most recent quarter, Pep Boys posted its first loss in three years.
Clearly, with Pep Boys going private, it won't have time to dig itself out of the cellar. But you can bet on having another chance to invest in Pep Boys years down the road -- and by then, it may well look like a much different company.
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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