Is Limited Brands 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 Limited Brands (NYSE: LTD  ) 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 Limited Brands.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% (0.2%) Fail
  1-Year Revenue Growth > 12% 11.4% Fail
Margins Gross Margin > 35% 43.2% Pass
  Net Margin > 15% 8.4% Fail
Balance Sheet Debt to Equity < 50% 173.6% Fail
  Current Ratio > 1.3 1.72 Pass
Opportunities Return on Equity > 15% 44.0% Pass
Valuation Normalized P/E < 20 14.74 Pass
Dividends Current Yield > 2% 2.5% Pass
  5-Year Dividend Growth > 10% 5.9% 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, Limited Brands lands in the middle of the pack. The retailer behind Victoria's Secret and Bath & Body Works has struggled with high debt levels and slow growth, but its stock trades at a reasonable valuation and pays a good dividend.

For a long time, Limited Brands has seen just about no growth in revenue, dissuading many investors from getting interested in the stock. But as Fool analyst Sean Sun notes, the retailer has been undergoing a major shift. Since 1998, the company has cut its number of stores in half, yet it has maintained revenue levels constant, meaning each of its stores is working roughly twice as hard to bring in sales. Moreover, the company is finally getting on the international bandwagon, opening its first Victoria's Secret store outside the U.S. just last year.

Recently, that transformation has started paying off for the company, as Limited joined higher-end retailers Abercrombie & Fitch (NYSE: ANF  ) and Saks (NYSE: SKS  ) in reporting strong results for the holiday season. With sales growth of 11% for the year and Victoria's Secret comps coming in at 14%, things are looking up for Limited going forward.

One area of concern, though, is Limited's debt. Unlike debt-free Gap (NYSE: GPS  ) and American Eagle Outfitters (NYSE: AEO  ) , Limited has more than $2.5 billion in debt on its books, and it recently announced plans to borrow $750 million more to finance a share buyback.

Limited Brands looks like it has turned the corner. If it can get its capital management under control, then it might look even more like a perfect stock in the future.

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 Limited Brands 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 Fool owns shares of Limited Brands. 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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