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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 Kroger (NYSE: KR ) 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 Kroger.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||6.4%||Fail|
|1-Year Revenue Growth > 12%||8.5%||Fail|
|Margins||Gross Margin > 35%||21.2%||Fail|
|Net Margin > 15%||0.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||200.2%||Fail|
|Current Ratio > 1.3||0.81||Fail|
|Opportunities||Return on Equity > 15%||13.3%||Fail|
|Valuation||Normalized P/E < 20||10.76||Pass|
|Dividends||Current Yield > 2%||2.1%||Pass|
|5-Year Dividend Growth > 10%||10.8%||Pass|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Kroger last year, the company has maintained its score of three points. But weaker returns on equity contributed to the stock's drop of nearly 15% over the past year.
The grocery retail business has become extremely cutthroat. Given high crop prices, margins have been slashed to nearly nothing, and that's put many grocery store chains under a lot of pressure. SUPERVALU (NYSE: SVU ) decided earlier this month to suspend its dividend and seek a potential sale of the company, while Safeway (NYSE: SWY ) also saw its stock get punished even though it narrowly beat earnings estimates last week.
Kroger also has to deal with competition from beyond its traditional rivals. Whole Foods (Nasdaq: WFM ) continues to wow investors and shoppers both, with its customers willing to pay marked-up prices that produce big profit margins for the company. Meanwhile, Wal-Mart and Target (NYSE: TGT ) are attacking the low end of the business by adding groceries to their broader retail concepts.
Still, Kroger has actually held up pretty well. The company has posted 34 straight quarters of rising same-store sales, and in its most recent quarter, Kroger forecast a better year ahead as its customer-loyalty program has allowed it to target discounts and coupons better, attracting more customers. Unfortunately, if the current drought boosts food prices as much as many fear, then Kroger could again see strain on its margins going forward.
For Kroger to improve, it needs to focus on its strengths as a traditional grocery store rather than trying to change itself to adapt to competition. If it can make its stores as efficient as possible, then Kroger could move a bit closer toward perfection in the years ahead.
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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Click here to add Kroger to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.