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 Estee Lauder (NYSE: EL ) 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 Estee Lauder.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||6.7%||Fail|
|1-Year Revenue Growth > 12%||10.3%||Fail|
|Margins||Gross Margin > 35%||79.5%||Pass|
|Net Margin > 15%||8.8%||Fail|
|Balance Sheet||Debt to Equity < 50%||46.9%||Pass|
|Current Ratio > 1.3||1.81||Pass|
|Opportunities||Return on Equity > 15%||31.9%||Pass|
|Valuation||Normalized P/E < 20||30.00||Fail|
|Dividends||Current Yield > 2%||0.8%||Fail|
|5-Year Dividend Growth > 10%||16.0%||Pass|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Estee Lauder last year, the company has dropped a point, with revenue growth having slowed in the past year. But that hasn't stopped the stock from putting up stellar performance, rising almost 45% over the past year.
Some might argue that high-end cosmetics might be an obvious casualty of tough economic times. But even throughout a tepid recovery, Estee Lauder's success has been representative of the industry as a whole. Ulta Salon (Nasdaq: ULTA ) has cashed in on the popularity of its specialty beauty products, and rivals Elizabeth Arden (Nasdaq: RDEN ) and Revlon (NYSE: REV ) have also seen substantial share-price strength even as Revlon moves forward with restructuring efforts.
But for anyone who thinks that Estee Lauder's business model is impregnable, the sad story of Avon Products (NYSE: AVP ) should serve as a reminder that what goes up can come down. Avon has languished under a mountain of debt and slow worldwide growth despite having had a strategy that seemed tailor-made for the rise of emerging-market economies.
In its most recent quarter, Estee Lauder gave investors great news, with revenue rising 9% on a 25% jump in profits. With strength in the U.S. and China, Estee Lauder is outpacing the rest of the industry and looking good doing it.
For Estee Lauder to improve, it could really use a nice boost to the overall economy to help it try to raise its margins and get earnings up in line with its share-price appreciation. If an economic recovery gets stronger, then Estee Lauder could 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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