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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 Kellogg (NYSE: K ) 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 Kellogg.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||3.4%||Fail|
|1-Year Revenue Growth > 12%||4.7%||Fail|
|Margins||Gross Margin > 35%||41.1%||Pass|
|Net Margin > 15%||9.3%||Fail|
|Balance Sheet||Debt to Equity < 50%||283.3%||Fail|
|Current Ratio > 1.3||0.80||Fail|
|Opportunities||Return on Equity > 15%||56.0%||Pass|
|Valuation||Normalized P/E < 20||16.52||Pass|
|Dividends||Current Yield > 2%||3.4%||Pass|
|5-Year Dividend Growth > 10%||8.1%||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Kellogg last year, the company has kept its four-point score. Yet despite a lagging stock price, the company has made big moves to expand its reach.
As a food company producing cereal and other food staples, Kellogg has some built-in stability in its business. Yet Kellogg isn't immune from the same rising prices for raw ingredients that have plagued competitors Kraft Foods (NYSE: KFT ) and General Mills (NYSE: GIS ) . With a popular brand name, Kellogg has been able to pass on some of those costs to its shoppers, but the margin compression over the past year shows that it hasn't been a complete solution.
Europe has also been a problem for Kellogg. Last month, the company guided its full-year 2012 profit projections well below where analysts had expected, sending shares skidding 6% the day of the announcement.
But earlier this year, Kellogg pulled off a coup that could boost results in the future. Diamond Foods (Nasdaq: DMND ) appeared to have a lock on buying the Pringles unit that Procter & Gamble (NYSE: PG ) owned, but after facing accounting problems, Diamond lost out, and P&G ended up selling Pringles to Kellogg. By letting Kellogg expand further beyond a slow core cereal segment, the Pringles pickup should give the business a pop, tripling its international snack presence.
To keep improving, Kellogg needs to get the Pringles acquisition integrated into its operations and then start working on getting its massive debt load under control. Given enough time, Kellogg could become a perfect stock -- but it won't happen in the near future.
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 the best investments from the rest.
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