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 Office Depot (NYSE: ODP ) 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 Office Depot.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(5.2%)||Fail|
|1-Year Revenue Growth > 12%||(1.2%)||Fail|
|Margins||Gross Margin > 35%||29.8%||Fail|
|Net Margin > 15%||0.8%||Fail|
|Balance Sheet||Debt to Equity < 50%||62.1%||Fail|
|Current Ratio > 1.3||1.34||Pass|
|Opportunities||Return on Equity > 15%||8.9%||Fail|
|Valuation||Normalized P/E < 20||15.31||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||2 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Office Depot last year, the company has doubled its score. Yet even though its valuation has become much more reasonable, the office products retailer still faces some big challenges.
Office Depot has failed to perform well over the past several years. Although rival Staples (Nasdaq: SPLS ) has boosted its sales even in a tough economy, Office Depot has seen a big contraction in revenue since 2007. Those sales declines, combined with ultra-thin margins, have left Office Depot in a position in which it can't afford to pay a dividend and has had trouble generating both profits and positive free cash flow. That's why Fool analyst Anand Chokkavelu picked Office Depot as a stock to sell while keeping Staples as a stock to buy.
Office Depot has tried to use its Internet prowess to build up sales. Yet even though the company is in the top 10 online sellers, it lags well behind Staples. And with retail giant Wal-Mart (NYSE: WMT ) getting into office supplies and Amazon.com (Nasdaq: AMZN ) posing a constant threat to any retailer that expects to expand via Internet-based sales, Office Depot will have its hands full trying to engineer a turnaround.
Still, the tide looks like it may be turning, as Office Depot beat earnings expectations by posting a $0.03 per share profit in its most recent quarter. Yet while both it and OfficeMax (NYSE: OMX ) performed better than analysts had expected, it's still unclear how Office Depot will be able to ramp up profitability enough to keep the stock's price up.
For Office Depot to keep moving up, it needs to find a way to differentiate itself from Staples and boost its profit margins and revenue. Without that, it seems likely that Office Depot's best answer would be to try to convince one of its rivals to buy it out.
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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