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 Select Comfort (Nasdaq: SCSS ) 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 Select Comfort.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(1.6%)||Fail|
|1-Year Revenue Growth > 12%||22.7%||Pass|
|Margins||Gross Margin > 35%||63.3%||Pass|
|Net Margin > 15%||8.1%||Fail|
|Balance Sheet||Debt to Equity < 50%||0.2%||Pass|
|Current Ratio > 1.3||1.61||Pass|
|Opportunities||Return on Equity > 15%||64.6%||Pass|
|Valuation||Normalized P/E < 20||33.35||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With five points, Select Comfort finishes in the dead-center of the pack. But its stock performance lately is anything but middle-of-the-road, having more than doubled since October.
A few years back, investors had left Select Comfort for dead. Its pricey mattresses didn't fit well with the recession-plagued economy, as revenue evaporated and share prices plunged to just pennies per share. But quietly, the company put together a string of good earnings reports, topping analyst expectations 12 straight times and regaining strong profitability. That's a far cry from what fellow mattress-maker Sealy (NYSE: ZZ ) has gone through lately, with ongoing losses and pressure on revenue leading to a near-revolt by shareholders.
Select Comfort doesn't have the industry to itself, however. Tempur-Pedic (NYSE: TPX ) has also seen big gains in its shares, and it has superior margins as well as having launched a product to compete more directly against Select Comfort's Sleep Number systems. Newly public Mattress Firm (Nasdaq: MFRM ) has also burst onto the scene with a bang, sporting a double from its IPO price in November as it earned $0.56 per share in the January quarter.
Select Comfort has made shareholders very happy. But it's going to have a harder time maintaining growth in the years to come. For the stock to get closer to perfection, Select Comfort has to focus on boosting margins while still staying competitive.
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.
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