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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 Rent-A-Center (Nasdaq: RCII ) 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 Rent-A-Center.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||2.1%||Fail|
|1-Year Revenue Growth > 12%||8.8%||Fail|
|Margins||Gross Margin > 35%||69.7%||Pass|
|Net Margin > 15%||5.8%||Fail|
|Balance Sheet||Debt to Equity < 50%||46.6%||Pass|
|Current Ratio > 1.3||0.53||Fail|
|Opportunities||Return on Equity > 15%||12.6%||Fail|
|Valuation||Normalized P/E < 20||12.08||Pass|
|Dividends||Current Yield > 2%||1.8%||Fail|
|5-Year Dividend Growth > 10%||NM||NM|
|Total Score||3 out of 9|
Source: S&P Capital IQ. NM = not meaningful; Rent-A-Center paid its first dividend in August 2010. Total score = number of passes.
Since we looked at Rent-A-Center last year, the company hasn't improved on its three-point score. But the stock has done quite well, rising nearly 30% over the past year.
In a tough economy, Rent-A-Center has given consumers a way to get the things they want without shelling out a lot of upfront cash. Given the challenges that electronics retailer Best Buy (NYSE: BBY ) has faced with falling sales and customers seeking to save money by shopping online, Rent-A-Center's model of offering electronics, furniture, and other high-priced items at cheap weekly or monthly prices has been pretty successful. Moreover, as banks have reined in consumer credit, the rental model avoids the need for conventional financing.
But Rent-A-Center doesn't have the industry to itself. Competition from rival Aaron's (NYSE: AAN ) forces Rent-A-Center to keep its prices in line, and Aaron's has actually done a better job than Rent-A-Center of keeping margins high and returns on equity up. Moreover, unlike industrial rental specialists United Rentals (NYSE: URI ) and H&E Equipment (Nasdaq: HEES ) and their business-oriented approach in offering essential equipment, many of the products that Rent-A-Center offers aren't absolute necessities.
Rent-A-Center is in a bit of a catch-22. On one hand, an improving economy would potentially build its customer base, but only if the economy doesn't improve so much that its customers can move up to buying what they want outright. Until it figures out how to attract better-off customers to its business model, Rent-A-Center will have trouble reaching 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.
Rent-A-Center investors can learn a lot from the challenges that conglomerate General Electric has had to overcome. Learn all about them in the Fool's premium report on GE. You can't afford to miss our top analysts' commentary. Try it out today.
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