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%||10.4%||Fail|
|1-Year Revenue Growth > 12%||(1.5%)||Fail|
|Margins||Gross Margin > 35%||33.1%||Fail|
|Net Margin > 15%||2.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||32.0%||Pass|
|Current Ratio > 1.3||2.44||Pass|
|Opportunities||Return on Equity > 15%||16.5%||Pass|
|Valuation||Normalized P/E < 20||21.14||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Aeropostale last year, the company has fallen by two points. Lower margins and dramatically higher valuations are responsible for the drop, yet the stock has managed to recover strongly after a dismal performance last autumn.
Aeropostale has had a tough few years. During the recession, the company did a good job of undercutting competitors Abercrombie & Fitch (NYSE: ANF ) and American Eagle Outfitters (NYSE: AEO ) , getting ahead of the price-reduction curve. But when those competitors followed suit, the entire industry suffered from lower margins and was particularly vulnerable when rising cotton prices pressured their bottom lines even further.
But shortly after the stock hit bottom last fall, Aeropostale pushed its earnings estimates for the quarter higher, sending shares soaring. As cotton prices have started to come back down, margins are starting to improve a bit again, and the industry is starting to get its share of analyst upgrades again.
Still, Aeropostale has a lot of work to do. In its most recent quarter, same-store sales were flat, and Abercrombie and Urban Outfitters (Nasdaq: URBN ) are outpacing Aeropostale in terms of providing fashionable apparel. Meanwhile, even Gap (NYSE: GPS ) has managed to boost its margins well above Aeropostale's recently.
For Aeropostale to get back on top, it needs to reverse stagnant sales trends and focus on recapturing fickle teen shoppers. That won't necessarily be easy, but it's definitely doable -- and if it's successful, Aeropostale could get back on the road to perfection in the next several years.
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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