Has Dollar General Become the Perfect Stock?

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 and then decide whether Dollar General (NYSE: DG  ) 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.
  • Moneymaking 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 Dollar General.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

11%

Fail

 

1-year revenue growth > 12%

8.2%

Fail

Margins

Gross margin > 35%

31.7%

Fail

 

Net margin > 15%

5.9%

Fail

Balance sheet

Debt to equity < 50%

55.7%

Fail

 

Current ratio > 1.3

1.54

Pass

Opportunities

Return on equity > 15%

19.7%

Pass

Valuation

Normalized P/E < 20

17.69

Pass

Dividends

Current yield > 2%

0%

Fail

 

5-year dividend growth > 10%

0%

Fail

       
 

Total score

 

3 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Dollar General last year, the company has given back one of the two points it gained from 2011 to 2012. The stock has held its own fairly well, rising between 5% and 10% over the past year.

The low end of the retail chain has been a good place for many companies lately, as continued worries about the strength of the economic recovery have kept customers going to discounters. Dollar General has done its best to hold off rising competition by aggressively expanding, with plans to open more than 600 new stores this year.

The fiscal cliff debate at the beginning of the year, however, hit low-income shoppers hardest, as the disappearance of temporary payroll tax reductions increased withholding and reduced take-home pay for workers of all income levels. The resulting decline had Wal-Mart (NYSE: WMT  ) asking where all of its customers had gone, as it issued cautious guidance about the current quarter. Similarly, just last week, teen-discounter Five Below (NASDAQ: FIVE  ) announced strong past results but forecast weaker guidance for the current quarter, sending shares downward on fears that its growth might not be sustainable.

Yet Dollar General hasn't seen those pressures yet. In its most recent quarterly earnings report, Dollar General managed to set record highs for the fourth quarter and the full 2012 year in terms of revenue, net profit, and earnings per share. The company also said that it expects year-over-year sales growth of 10% to 12%, with similar percentage gains in earnings per share as well.

For Dollar General to improve, it needs its expansion to produce not just higher revenue but also better margins and earnings growth. Otherwise, the dollar store may never get much closer to perfection.

Keep searching
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.

The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

Click here to add Dollar General to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.


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