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 Safeway (NYSE: SWY ) 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 Safeway.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||1.7%||Fail|
|1-Year Revenue Growth > 12%||6.3%||Fail|
|Margins||Gross Margin > 35%||28.2%||Fail|
|Net Margin > 15%||1.2%||Fail|
|Balance Sheet||Debt to Equity < 50%||146.7%||Fail|
|Current Ratio > 1.3||0.83||Fail|
|Opportunities||Return on Equity > 15%||11.9%||Fail|
|Valuation||Normalized P/E < 20||13.01||Pass|
|Dividends||Current Yield > 2%||2.6%||Pass|
|5-Year Dividend Growth > 10%||20.1%||Pass|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With three points, Safeway has a lot of work to do. The cutthroat grocery industry routinely involves thin margins and ubiquitous competition, and finding ways to distinguish one company from another is an ever-present challenge.
Grocery stores largely sell exactly the same items, and so many of them have to resort to competing solely on price. That usually does a number on margins, making Safeway and its peers susceptible to higher supply costs.
But one way that Safeway is trying to distinguish itself is to focus more on building a loyal customer base. Through capital improvements, the company is trying to make its stores more attractive to its customers. Yet the company has also kept enough cash back to pay an attractive dividend.
One controversy has hit not only Safeway but also several of its competitors. When news came out that ground beef at several grocery chains contained what's known as "pink slime" as filler, Safeway, SUPERVALU (NYSE: SVU ) , and Kroger (NYSE: KR ) were among those announcing that they would stop using the filler in their beef.
Whether the controversy will create a big backlash is uncertain, but anything that calls into question the quality of a chain's food has the potential to be bad news. That's especially true when competitors Whole Foods (Nasdaq: WFM ) and Fresh Market (Nasdaq: TFM ) represent themselves as natural and organic food specialists that sell products specifically to avoid controversies like this.
Many investors now think Safeway's best bet is a potential takeover bid, as shares have moved up more than 10% in the past week and a half on speculation that a bid for the company may be coming. But if it carries on independently, Safeway first needs to get its debt under control. Margins may never expand to the point where Safeway could become a perfect stock, but the company has plenty of room for realistic improvement in the years to come.
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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