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 Flowers Foods (NYSE: FLO ) 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 Flowers Foods.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||8.2%||Fail|
|1-Year Revenue Growth > 12%||11.2%||Fail|
|Margins||Gross Margin > 35%||46.2%||Pass|
|Net Margin > 15%||4.2%||Fail|
|Balance Sheet||Debt to Equity < 50%||63.6%||Fail|
|Current Ratio > 1.3||2.02||Pass|
|Opportunities||Return on Equity > 15%||15.2%||Pass|
|Valuation||Normalized P/E < 20||22.82||Fail|
|Dividends||Current Yield > 2%||3.3%||Pass|
|5-Year Dividend Growth > 10%||22.2%||Pass|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Flowers Foods last year, the company has lost a point. Debt-to-equity levels have risen above critical levels, although faster revenue growth has helped lift shares by about 10%.
Until recently, Flowers was absolutely flying high. The company had made a potentially valuable acquisition, buying Lepage Bakeries and boosting its already-dominant market share in direct-to-store bread and bakery delivery even further. Moreover, it had been strong enough to increase its dividend, just the latest in a long streak of hikes over the years.
But this year's drought will once again bring a big shock to the food industry. Already, food giants General Mills (NYSE: GIS ) and Kellogg (NYSE: K ) have had to deal with rising costs of the raw ingredients that go into their products. Archer Daniels Midland (NYSE: ADM ) in particular expects to see tighter margins for the high-fructose corn syrup that so many processed-food makers rely on. With crops under severe pressure this year, Flowers will face similar problems, hurting margins and forcing price increases.
Still, the company has a huge advantage: its distribution network. Because small local bakeries have challenges getting their products to market, Flowers presents a win-win scenario when it acquires them, as it can often boost production and expand market share. That's a benefit we've seen in the drink industry, where Honest Tea got a big boost from associating with Coca-Cola (NYSE: KO ) .
For Flowers to keep improving and justify its somewhat inflated valuation, it needs to take advantage of tough conditions to keep acquiring weaker players and then unlocking their whole value. If it can do so, then Flowers has plenty of potential to keep raising its dividend and get closer to 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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