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 Colgate-Palmolive (NYSE: CL ) 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 Colgate-Palmolive.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||5.6%||Fail|
|1-Year Revenue Growth > 12%||5.7%||Fail|
|Margins||Gross Margin > 35%||57.6%||Pass|
|Net Margin > 15%||14.4%||Fail|
|Balance Sheet||Debt to Equity < 50%||213.7%||Fail|
|Current Ratio > 1.3||1.48||Pass|
|Opportunities||Return on Equity > 15%||91.9%||Pass|
|Valuation||Normalized P/E < 20||21.39||Fail|
|Dividends||Current Yield > 2%||2.3%||Pass|
|5-Year Dividend Growth > 10%||11.5%||Pass|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Colgate-Palmolive last year, the company has fallen by a point. Falling margins and a higher valuation are to blame for the loss, although the stock has climbed more than 20% over the past year.
Colgate has the same attractive traits that many of its consumer-products peers have: a defensive orientation in tough stock market environments. Like Procter & Gamble (NYSE: PG ) and Kimberly-Clark (NYSE: KMB ) , Colgate's stock won't give you outperformance during big bull markets, but it tends to hold up quite well when the rest of the market is giving up ground.
But the popularity of defensive names, especially ones that pay decent dividends, has led investors to bid up shares so far that they've become fairly expensive. P&G, Kimberly-Clark, and Clorox (NYSE: CLX ) all have fairly high P/Es, and Colgate takes the prize for the highest earnings multiple at the moment.
Moreover, higher raw materials costs have taken their toll on the consumer-products industry. Yet Colgate has maintained the highest margins among its major competitors, partly by cutting costs and partly by passing on price increases to customers.
In its earnings announcement earlier this week, Colgate eked out a 1% gain in net income on a 2% rise in revenue, overcoming the impact of a strong U.S. dollar and costs of raw materials. Emerging-market growth remains an important aspect of Colgate's overall growth, and the company still expects double-digit EPS growth going forward, as long as currency impacts become less severe.
For Colgate to improve, it needs to reverse the troubling trend of weaker margins. As long as cyclical trends in raw-materials costs eventually head lower, the company could get a bit closer to perfection before too long.
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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