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 Sotheby's (NYSE: BID ) 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 Sotheby's.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(1.4%)||Fail|
|1-Year Revenue Growth > 12%||(14.7%)||Fail|
|Margins||Gross Margin > 35%||56.4%||Pass|
|Net Margin > 15%||15.5%||Pass|
|Balance Sheet||Debt to Equity < 50%||48.4%||Pass|
|Current Ratio > 1.3||1.45||Pass|
|Opportunities||Return on Equity > 15%||12.3%||Fail|
|Valuation||Normalized P/E < 20||20.52||Fail|
|Dividends||Current Yield > 2%||1%||Fail|
|5-Year Dividend Growth > 10%||(6.2%)||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Sotheby's last year, the company has seen its score drop two points. Plunging revenue is largely to blame, and even though the share price fell about 5% in the past year, earnings multiples have moved up considerably, signaling weak earnings as well.
It's been very much an up-and-down year for Sotheby's. That's not terribly surprising, given that the auction business tends to be extremely cyclical, and a lot depends on which items happen to come to market in any given year. Late last year, for instance, the company had an excellent series of sales that included the original contract signed in 1976 by Apple (Nasdaq: AAPL ) co-founders Steve Jobs, Steve Wozniak, and Ronald Wayne. The contract fetched $1.59 million at auction last December, more than 10 times the $150,000 pre-auction estimate.
But all those gains reversed themselves earlier this year, when earnings results weren't as good. In its first-quarter report, Sotheby's missed on earnings-per-share estimates, posting a modest loss for the quarter.
The bigger concern long-term is that the once-invulnerable luxury sector has started to crater. Among high-end retailers, both Coach (NYSE: COH ) and Tiffany (NYSE: TIF ) have suffered big losses from their highs earlier this year, as slowdowns in Asia and extreme weakness in Europe have contributed to worsening results. One of the hardest-hit companies was Fossil (Nasdaq: FOSL ) , which lost more than half its value after reporting disappointing results. Nothing says luxury more than million-dollar auctions, so it's not surprising to see Sotheby's join this group of poor-performing stocks.
For Sotheby's to improve, it needs the economy to get jump-started somehow. If that happens, then its earnings could finally catch up with its valuation. Otherwise, it could be a long time before anyone bids Sotheby's up toward 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 the best investments from the rest.
Sotheby's is doing OK, but Apple has some amazingly good prospects. Get the whole story from our top tech analysts with their views on Apple.
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