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Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?
One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Family Dollar (NYSE: FDO ) fits the bill.
The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.
Some of the most basic yet important things to look for in a stock are:
- 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 don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
- Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
- Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
- Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. 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 Family Dollar.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||6.2%||fail|
|1-Year Revenue Growth > 12%||6.3%||fail|
|Margins||Gross Margin > 35%||35.7%||pass|
|Net Margin > 15%||4.6%||fail|
|Balance Sheet||Debt to Equity < 50%||17.6%||pass|
|Current Ratio > 1.3||1.57||pass|
|Opportunities||Return on Equity > 15%||25%||pass|
|Valuation||Normalized P/E < 20||18.69||pass|
|Dividends||Current Yield > 2%||1.3%||fail|
|5-Year Dividend Growth > 10%||10.2%||pass|
|Total Score||6 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Family Dollar's score of 6 might not be perfect, but in the cutthroat, low-margin business of retail, it's tough for any company to score high marks on some of these measures. In that light, Family Dollar does reasonably well.
Some of that success comes from being in the right place at the right time. During the recession, Family Dollar, along with fellow discounters Dollar Tree (Nasdaq: DLTR ) and Dollar General (NYSE: DG ) , attracted lots of attention as cash-strapped consumers traded down in search of affordable bargains.
The stores have done so well that they've found some unlikely imitators. Wal-Mart (NYSE: WMT ) and Target (NYSE: TGT ) have tried out smaller stores in certain locations, trying to take lessons from the success Family Dollar and its competitors have enjoyed with their less-than-big-box-sized locations.
Family Dollar's main challenge is that the discount retail industry is very crowded. But what makes Family Dollar stand out for investors is its commitment to dividends. A 1.3% yield isn't much, but a consistent growth rate is good news for long-term shareholders. As long as Family Dollar can convince shoppers to stick around even once the economy rebounds, it should be able to maintain slow but steady growth that has made it surprisingly resilient during tough times.
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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