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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 Wal-Mart (NYSE: WMT ) 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 Wal-Mart.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||5.1%||Fail|
|1-Year Revenue Growth > 12%||6.9%||Fail|
|Margins||Gross Margin > 35%||24.9%||Fail|
|Net Margin > 15%||3.5%||Fail|
|Balance Sheet||Debt to Equity < 50%||73.7%||Fail|
|Current Ratio > 1.3||0.83||Fail|
|Opportunities||Return on Equity > 15%||23.5%||Pass|
|Valuation||Normalized P/E < 20||14.63||Pass|
|Dividends||Current Yield > 2%||2.4%||Pass|
|5-Year Dividend Growth > 10%||15.6%||Pass|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Wal-Mart last year, the company has kept its four-point score. But a 20% gain for the shares shows how the discount retailer has finally broken out of a slump and started growing again.
Wal-Mart's success in low-cost retail has been legendary. Yet after benefiting greatly during the recession and financial crisis in 2008, Wal-Mart saw a big slowdown that led to nine straight quarters of falling U.S. same-store sales.
More recently, though, Wal-Mart has started turning things around. Same-store sales have now risen three quarters in a row, and with concerns about the future of the economy getting larger, Wal-Mart is again capturing the attention of shoppers looking to save. The company has also responded to competition from deep-discounting dollar stores by trying out smaller store formats, a move that could also help it fight against losing business to online retail giant Amazon.com (Nasdaq: AMZN ) .
One area where Wal-Mart has stayed ahead of its competition is in global expansion. While Target (NYSE: TGT ) and Costco (Nasdaq: COST ) are largely domestically focused, Wal-Mart has more than half of its stores located outside North America. That should help give Wal-Mart an edge in the long run as emerging markets expand, although it will have to deal with PriceSmart (Nasdaq: PSMT ) and other international retailers already doing business in overseas markets.
The big controversy on everyone's minds with Wal-Mart is its recent Mexican bribery scandal. But already, investors seem to be moving past that to refocus on Wal-Mart's growth potential. If it can put the bribery episode behind it, Wal-Mart has the potential to produce impressive gains in the next economic cycle and beyond.
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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