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 Abercrombie & Fitch (NYSE: ANF ) 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 Abercrombie & Fitch.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||4.6%||Fail|
|1-Year Revenue Growth > 12%||19.9%||Pass|
|Margins||Gross Margin > 35%||60.6%||Pass|
|Net Margin > 15%||3.1%||Fail|
|Balance Sheet||Debt to Equity < 50%||3.1%||Pass|
|Current Ratio > 1.3||2.11||Pass|
|Opportunities||Return on Equity > 15%||6.8%||Fail|
|Valuation||Normalized P/E < 20||22.79||Fail|
|Dividends||Current Yield > 2%||1.4%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Abercrombie & Fitch last year, the company has sustained its four-point score. But the younger-end retail environment remains extremely competitive, and that bodes ill for Abercrombie finding much improvement in margins and returns on equity anytime soon.
Retail lives and dies by the holiday shopping season, and this past one posed big challenges throughout the industry. Abercrombie competitors American Eagle Outfitters (NYSE: AEO ) had to do expensive, earnings-destroying promotions to move merchandise out the door, while Aeropostale (NYSE: ARO ) suffered a 10% drop in sales during the holiday season. Those poor results will put more pressure on Abercrombie to match its teen-retail rivals.
The bigger long-term threat to Abercrombie, though, is a potential paradigm shift in retail. rue21 (NYSE: RUE ) uses a "fast fashion" model to cycle in new styles much more quickly than traditional retailers like Abercrombie, which leaves it less exposed to huge inventory backlogs from misreading fashion trends.
In its most recent quarterly report, Abercrombie suffered from a big drop in profits but gave promising guidance going forward. The company believes that international growth is the key to its success, with hopes that its global business will produce earnings above analyst expectations. But similar optimism in the past has failed to bring positive results.
To improve, Abercrombie needs to find ways to reduce its promotional discounting and boost margins. With valuations fairly high despite a big drop in the stock over the past year, however, it's unrealistic to expect Abercrombie to become a perfect stock anytime soon.
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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