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 Ulta Salon (Nasdaq: ULTA ) 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 Ulta Salon.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||18.7%||Pass|
|1-Year Revenue Growth > 12%||22.1%||Pass|
|Margins||Gross Margin > 35%||34.7%||Fail|
|Net Margin > 15%||6.8%||Fail|
|Balance Sheet||Debt to Equity < 50%||0%||Pass|
|Current Ratio > 1.3||3.52||Pass|
|Opportunities||Return on Equity > 15%||24.4%||Pass|
|Valuation||Normalized P/E < 20||49.50||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, Ulta Salon isn't the prettiest stock out there. But the company has burst onto the scene with amazing growth, and its shares have rewarded ground-floor investors with impressive gains.
Sometimes, a company fills a niche that for some reason has eluded discovery. In Ulta's case, what it brings to the table is a full array of more than 20,000 items, covering cosmetics, perfume, and hair-care products. Combine that with a full-service salon in each of its nearly 450 locations, and you have a one-stop shopping experience.
That may seem very simple, but bringing the entire cosmetics universe under one roof is something the competition simply doesn't do. Big-box retailers Target (NYSE: TGT ) and Wal-Mart (NYSE: WMT ) have had success sticking with the low-end products that its average customer gravitates toward, but they don't give serious customers the premium products they want. Meanwhile, Nordstrom (NYSE: JWN ) keeps up its upscale reputation by stocking premium products, but tends to avoid giving its customers more pedestrian options. Ulta delivers it all, and that has helped it build a loyal customer base.
Ulta has turned that business model into huge growth. In its most recent quarter, the company saw net income jump 58%, as it boosted both revenue and profit margins -- a key element of success in any retail company. Although some fear that Amazon.com (Nasdaq: AMZN ) could compete on price, Ulta features a much more tactile experience than some of the other areas where Amazon has excelled, such as consumer electronics. That makes it more likely Ulta customers will just buy products there.
To keep improving, Ulta needs to translate its fast growth into stronger margins and a more lucrative product mix. Diversifying into the men's grooming area could be a growth booster -- or a major misstep, if the company misreads consumer trends there. In any event, Ulta will definitely be worth watching in the years to come.
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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