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 Costco
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 Costco.
|
Factor |
What We Want to See |
Actual |
Pass or Fail? |
|---|---|---|---|
| Growth | 5-year annual revenue growth > 15% | 8.1% | Fail |
| 1-year revenue growth > 12% | 14.1% | Pass | |
| Margins | Gross margin > 35% | 12.6% | Fail |
| Net margin > 15% | 1.6% | Fail | |
| Balance sheet | Debt to equity < 50% | 18.4% | Pass |
| Current ratio > 1.3 | 1.14 | Fail | |
| Opportunities | Return on equity > 15% | 13.1% | Fail |
| Valuation | Normalized P/E < 20 | 25.04 | Fail |
| Dividends | Current yield > 2% | 1.1% | Fail |
| 5-year dividend growth > 10% | 12.7% | Pass | |
| Total score | 3 out of 10 |
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Costco last year, the company has actually improved its score by a point, as its revenue growth over the past year has risen sharply. Despite its low score, the retailer has masterfully navigated a low-margin industry, but some now wonder what its future will look like with a new CEO.
Costco is well-regarded as a leader in the big-box retail industry, with its warehouse membership model producing profits not only from selling goods but also from annual fee revenue. With an emphasis on customer service, employee retention, and low prices, Costco has seen much faster growth than Wal-Mart
Despite its obvious appeal to bargain-hunters, Costco appeals to more higher-income customers than ultra-discounters like Dollar General
One of Costco's biggest pushes over the years has been toward building e-commerce sales. Although its online operation will never rival Amazon.com
With CEO Jim Sinegal retiring, some fear that Costco's magic could go away. But with the system Sinegal put in place, his successor should be able to push Costco closer to perfection in the years to come.
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 Costco 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 ."
