Is Talbots 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, then decide if Talbots (NYSE: TLB  ) 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 Talbots.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% (7.7%) Fail
  1-Year Revenue Growth > 12% (1.8%) Fail
Margins Gross Margin > 35% 37.7% Pass
  Net Margin > 15% 0.9% Fail
Balance Sheet Debt to Equity < 50% 13.9% Pass
  Current Ratio > 1.3 1.38 Pass
Opportunities Return on Equity > 15% NM NM
Valuation Normalized P/E < 20 12.13 Pass
Dividends Current Yield > 2% 0% Fail
  5-Year Dividend Growth > 10% 0% Fail
       
  Total Score   4 out of 9

Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful; Talbots had negative average equity during the period. Total score = number of passes.

Talbots can only earn four points on our scale. The retailer has been trying to turn around for a long time, but so far, it's still mired in the doldrums.

Talbots was once a highly profitable retailer catering to older female shoppers. Unfortunately, that space is incredibly crowded now, with competitors that include Chico's (NYSE: CHS  ) , Coldwater Creek (Nasdaq: CWTR  ) , and ANN (NYSE: ANN  ) . All of those retailers have seen tough times, but none of them has seen worse revenue contraction over the past five years than Talbots.

Meanwhile, Talbots has tried to revamp its "frumpy" image for years. But first, the financial crisis made things difficult for retailers of all types. And even after the stock market recovered, Baby Boomers are still struggling with a new economic reality that doesn't support high-end purchases that were once Talbots' bread and butter.

All those headwinds left Talbots with losses, crashing same-store sales, and the prospects of further store closures and downsizing ahead. Combined with concerns over rich executive compensation, the future for Talbots doesn't look good for investors.

Even at a relatively low normalized earnings multiple, Talbots isn't a perfect stock. Until the company can actually make progress with a reasonable turnaround strategy, you should be skeptical of its future prospects.

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.

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

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our 13 Steps to Investing Foolishly.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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