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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 Aeropostale (NYSE: ARO ) 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 Aeropostale.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||14.2%||Fail|
|1-Year Revenue Growth > 12%||5.3%||Fail|
|Margins||Gross Margin > 35%||40.9%||Pass|
|Net Margin > 15%||8.4%||Fail|
|Balance Sheet||Debt to Equity < 50%||0.0%||Pass|
|Current Ratio > 1.3||1.98||Pass|
|Opportunities||Return on Equity > 15%||50.2%||Pass|
|Valuation||Normalized P/E < 20||7.58||Pass|
|Dividends||Current Yield > 2%||0.0%||Fail|
|5-Year Dividend Growth > 10%||0.0%||Fail|
|Total Score||5 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of 5, Aeropostale lands in the middle of the pack. The retailer did better than many of its competitors during the recession, but now, despite a rebounding economy, Aeropostale is having trouble getting traction going forward.
As a clothing retailer, Aeropostale is vulnerable to the whims of fashion. Yet that worked in its favor during the recession, as the company managed to sustain positive same-store sales in its 2008, 2009, and 2010 fiscal years. Meanwhile, Abercrombie & Fitch (NYSE: ANF ) and American Eagle Outfitters (NYSE: AEO ) suffered big drops in comps, with Abercrombie posting a huge 23% same-store sales decline in fiscal 2010.
But recently, Aeropostale has faced challenges again. In its most recent quarter, the company fell short of revenue expectations and dramatically cut forward earnings guidance. And although some of its competitors, including Gap (NYSE: GPS ) and Wet Seal (Nasdaq: WTSLA ) , have faced similarly pessimistic forecasts as higher cotton prices hurt margins, Abercrombie is now steadfastly encouraging its investors with positive guidance.
The shares currently carry a bargain price despite crushing its peers on return on equity. Although short-term pressures may justify the stock's low price, long-term factors suggest that Aeropostale could easily climb back toward perfection once those pressures ease.
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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