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 lululemon athletica (Nasdaq: LULU ) 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 lululemon athletica.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||46.6%||Pass|
|1-Year Revenue Growth > 12%||40.6%||Pass|
|Margins||Gross Margin > 35%||56.9%||Pass|
|Net Margin > 15%||18.4%||Pass|
|Balance Sheet||Debt to Equity < 50%||0%||Pass|
|Current Ratio > 1.3||5.10||Pass|
|Opportunities||Return on Equity > 15%||37.0%||Pass|
|Valuation||Normalized P/E < 20||58.74||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||7 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Lululemon last year, the stock has kept its seven-point score. Sales growth has slowed minimally, but the yoga apparel retailer continues to boast huge margins and a squeaky-clean balance sheet.
Despite skepticism among many investors, Lululemon has continued its high-growth trajectory. The company managed to boost revenue over the $1 billion mark in 2011, thanks in large part to a 20% increase in same-store sales for the year.
One interesting way in which Lululemon has bucked the trend its competitors set is in avoiding high-priced endorsement deals. Both Nike (NYSE: NKE ) and Under Armour (NYSE: UA ) have stables of athletic stars hawking their products, which has certainly been a successful approach for both. But Lululemon caters directly to yoga instructors and fitness trainers, building relationships that add up little by little to big market penetration.
Another competitive advantage lululemon has is in the materials it uses for its clothes. High cotton prices hurt margins at fellow clothing retailers Gap (NYSE: GPS ) and American Eagle Outfitters (NYSE: AEO ) , as low price points made any attempt to pass along increased costs a lot more obvious. But Lululemon benefits from using synthetic fabrics whose prices are more predictable and less volatile.
For Lululemon to continue growing, its most obvious move will be to go global. Having built out its U.S. presence in recent years, expanding further abroad beyond North America could position Lululemon to grow even faster. High valuations aren't going away anytime soon (and don't expect a dividend, either), but in the long run, Lululemon could still continue its winning ways.
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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