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 AutoZone (NYSE: AZO ) 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 AutoZone.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||6.8%||Fail|
|1-Year Revenue Growth > 12%||7.7%||Fail|
|Margins||Gross Margin > 35%||51.3%||Pass|
|Net Margin > 15%||10.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||NM||NM|
|Current Ratio > 1.3||0.83||Fail|
|Opportunities||Return on Equity > 15%||NM||NM|
|Valuation||Normalized P/E < 20||16.58||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||2 out of 8|
Source: S&P Capital IQ. NM = not meaningful due to negative shareholder equity. Total score = number of passes.
Since we looked at AutoZone last year, the company hasn't been able to improve on its two-point score. Yet the auto-parts retailer has managed to perform fairly well, with its shares up about 20% in the past year.
The state of the automotive industry has had a huge impact on both automotive parts retailers and automakers. Although General Motors successfully emerged from bankruptcy and Ford (NYSE: F ) survived its own near-death experience, trouble in Europe and less-than-stellar economic growth in the U.S. have hampered their recoveries.
By contrast, AutoZone and its peers have benefited greatly from a weak economy. With the average age of cars on the road at extremely high levels, car owners seeking to extend the lives of their vehicles spend more on the parts and maintenance items that AutoZone offers. That's a big part of why in a relatively sleepy industry, AutoZone has enjoyed nice growth and has maintained impressively wide margins for a retail business. Compared to Pep Boys (NYSE: PBY ) and Advance Auto Parts (NYSE: AAP ) , AutoZone outpaces its rivals on the margin front.
But even for top performers, it's hard to make strong growth last forever. O'Reilly Automotive (Nasdaq: ORLY ) plunged in June after announcing that it would miss second-quarter expectations, and the news pulled AutoZone down as well.
For AutoZone to improve, it needs to find a way to keep leading the industry. More importantly, it has to address what will happen when the economy improves and people start buying new cars again. Without such a strategy, AutoZone may never become a perfect stock.
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.
AutoZone has done OK, but Ford has a lot more going on with its business. Ford has faced its share of challenges, but it also has some good prospects. Learn more about the automaker with our brand-new premium report on Ford.
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