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 Hershey (NYSE: HSY ) 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 Hershey.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||4.7%||Fail|
|1-Year Revenue Growth > 12%||7.2%||Fail|
|Margins||Gross Margin > 35%||42.8%||Pass|
|Net Margin > 15%||10.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||225.1%||Fail|
|Current Ratio > 1.3||1.52||Pass|
|Opportunities||Return on Equity > 15%||74.4%||Pass|
|Valuation||Normalized P/E < 20||23||Fail|
|Dividends||Current Yield > 2%||2.2%||Pass|
|5-Year Dividend Growth > 10%||6.0%||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Hershey last year, the company has kept its four-point score. Yet even though the company's financial metrics look similar to how they looked this time last year, the stock has had a nice 20% rise over the past year.
Hershey may seem like a perfect defensive play in a tumultuous market. It's not as if its products ever go out of style, especially among its base of young customers.
But confectioners are feeling the pinch of rising cocoa prices. Hershey, Archer Daniels Midland (NYSE: ADM ) , and Kraft (NYSE: KFT ) are all low-margin businesses, and although they have strong enough brand names to pass on some costs to consumers, there's only so far they can go before volumes start to fall precipitously.
Hershey is responding by broadening its product line. It acquired Canada's Brookside Foods late last year, gaining its line of chocolate-covered fruit candies. Combined with ongoing product innovation, Hershey keeps its products interesting for customers, and that's a big part of how it has managed to keep its margins so much higher than fellow food giants Heinz (NYSE: HNZ ) and Campbell Soup (NYSE: CPB ) .
The problem Hershey faces is that its stock is already priced for perfection. Although its dividend yield is solid, Hershey needs to see declining cocoa prices in order to justify its current valuation. With huge amounts of debt on the books, Hershey won't get closer to perfection until it starts to get its earnings growth to catch up to its rising stock price.
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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