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 Ralph Lauren (NYSE: RL ) 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 Ralph Lauren.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||9.4%||Fail|
|1-Year Revenue Growth > 12%||14.8%||Pass|
|Margins||Gross Margin > 35%||58.2%||Pass|
|Net Margin > 15%||10.0%||Fail|
|Balance Sheet||Debt to Equity < 50%||7.5%||Pass|
|Current Ratio > 1.3||2.91||Pass|
|Opportunities||Return on Equity > 15%||20.7%||Pass|
|Valuation||Normalized P/E < 20||22.28||Fail|
|Dividends||Current Yield > 2%||1.1%||Fail|
|5-Year Dividend Growth > 10%||38.0%||Pass|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Ralph Lauren last year, the company has kept its six-point score. But the retailer has underperformed the broader market, rising only 10% versus an almost 20% jump in the S&P 500.
For years, Ralph Lauren has benefited from aiming at the luxury end of the retail spectrum. Even as lower-end companies have struggled to move their share prices higher, Ralph Lauren's stock has been hitting new all-time highs for almost two years now.
But the industry hasn't been invulnerable to macroeconomic concerns. Just as Fossil (Nasdaq: FOSL ) got hit hard back in May on concerns about falling earnings related to the European sovereign debt crisis, Ralph Lauren pulled back from recent highs. Despite a strong earnings report last week, Ralph Lauren projected weak sales for the current quarter. That raises questions about future growth, especially in light of competition from Michael Kors (NYSE: KORS ) and other rivals in the space.
Like many companies, Ralph Lauren is looking to Asia to fuel its growth ambitions. Even though Asian sales currently represent only an eighth of the company's revenue, Ralph Lauren hopes to increase that share to a third. That's been a recipe for success at Tiffany (NYSE: TIF ) , with the jeweler posting double-digit same-store sales gains in Asia. Coach (NYSE: COH ) has also focused on pushing into Asia, with new retail stores in China pushing its total there up to 85.
For Ralph Lauren to improve, the best case would be a resolution of economic troubles in Europe. A resumption of growth trends on the Continent could let the retailer's earnings catch up with its somewhat high valuation and provide just the sales boost Ralph Lauren needs to push itself closer to perfection.
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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