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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 Lowe's (NYSE: LOW ) 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 Lowe's.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||1.6%||Fail|
|1-Year Revenue Growth > 12%||5.3%||Fail|
|Margins||Gross Margin > 35%||34.4%||Fail|
|Net Margin > 15%||3.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||63.2%||Fail|
|Current Ratio > 1.3||1.24||Fail|
|Opportunities||Return on Equity > 15%||11.7%||Fail|
|Valuation||Normalized P/E < 20||14.48||Pass|
|Dividends||Current Yield > 2%||2.2%||Pass|
|5-Year Dividend Growth > 10%||22.9%||Pass|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Lowe's last year, the company has dropped a point. A slightly lower gross margin figure and higher debt overcame gains in its dividend yield, but despite the stock's strong performance throughout much of the year, shares have tumbled lately, making shareholders more nervous about the home improvement retailer.
With the housing market still is a state of confusion, Lowe's may not seem like an obvious place to make money. But both it and rival Home Depot (NYSE: HD ) have seen their shares soar recently, as fledging signs of a possible bottom for housing have made investors enthusiastic again. Even more specialized companies in the space have soared, with Lumber Liquidators (NYSE: LL ) enjoying a recent analyst upgrade after seeing rising sales and Trex (Nasdaq: TREX ) looking for a big turnaround in 2012.
Unfortunately, Lowe's hasn't performed as well as Home Depot. For the past three years, Home Depot has beaten Lowe's on same-store sales, including a 3.4% gain for Home Depot last year versus flat comps for Lowe's. In its most recent quarter, Lowe's topped earnings estimates, but the company warned that profits for the full year would be less than expected, sending shares tumbling.
Another uncertainty for Lowe's comes from the spinoff of Orchard Supply Hardware from Sears Holdings (Nasdaq: SHLD ) . Although Orchard's natural competitors are mom-and-pop small hardware stores rather than huge big-box retailers like Lowe's, Orchard still has a chance to take away some business from Lowe's because of Orchard having access to popular Sears brand names like Craftsman and Kenmore.
For Lowe's to improve, some stability in the housing market would really be a good first step. Although the company has done well to encourage remodeling and other thrifty projects, big-ticket items come from home sales, and Lowe's will do better if it can capitalize on them going forward.
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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