Is Zumiez 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 whether Zumiez (Nasdaq: ZUMZ  ) 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 Zumiez.

Factor What We Want to See Actual Pass or Fail?
Growth 5-Year Annual Revenue Growth > 15% 17.6% Pass
  1-Year Revenue Growth > 12% 18.0% Pass
Margins Gross Margin > 35% 36.3% Pass
  Net Margin > 15% 5.6% Fail
Balance Sheet Debt to Equity < 50% 0.0% Pass
  Current Ratio > 1.3 4.13 Pass
Opportunities Return on Equity > 15% 13.2% Fail
Valuation Normalized P/E < 20 26.43 Fail
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, Zumiez doesn't quite give shareholders the perfect fit. The retailer has seen some impressive growth in recent years despite the recession, but analysts aren't so sure about the company's future.

Zumiez is a teen-oriented retailer that targets the young skateboarder and surfer crowd. This turns out to be a fairly competitive market, but Zumiez has had better growth and returns on equity than Volcom (Nasdaq: VLCM  ) or Pacific Sunwear (Nasdaq: PSUN  ) . Yet like more general teen retailers such as Hot Topic (Nasdaq: HOTT  ) , Zumiez has found that dealing with the fickle trends of teen shoppers is always a challenge.

Recently, the company has started to feel the pinch of higher costs. Just as Aeropostale (NYSE: ARO  ) and Gap (NYSE: GPS  ) have warned of troubling forecasts ahead, cost inflation will increase Zumiez's average unit costs between 10% and 15% this year.

The news hasn't been all bad for Zumiez, though. Shares more than doubled between last August and the end of May, and yesterday, the company announced that same-store sales in May were up 7.8% from a year ago. Yet those cheery results weren't enough to dissuade two analysts from issuing downgrades based on valuation, sending the stock plummeting.

Even if Zumiez were to reach perfection, it probably wouldn't be able to hold onto it very long. Dealing with a changeable customer base is tough, and with thin margins, no dividend, and a high earnings multiple, Zumiez has three big strikes against it.

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 Zumiez 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. The Motley Fool owns shares of Aeropostale. Motley Fool newsletter services have recommended buying shares of Volcom and shorting Zumiez. 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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