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 Best Buy (NYSE: BBY ) 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 Best Buy.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||9.1%||Fail|
|1-Year Revenue Growth > 12%||(0.5%)||Fail|
|Margins||Gross Margin > 35%||25%||Fail|
|Net Margin > 15%||2.3%||Fail|
|Balance Sheet||Debt to Equity < 50%||37.2%||Pass|
|Current Ratio > 1.3||1.26||Fail|
|Opportunities||Return on Equity > 15%||18.6%||Pass|
|Valuation||Normalized P/E < 20||7.68||Pass|
|Dividends||Current Yield > 2%||2.5%||Pass|
|5-Year Dividend Growth > 10%||12.4%||Pass|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Best Buy last year, the electronics retailer has picked up a point. A dividend yield that has jumped substantially accounts for the change, but flatlining sales growth and a plunging stock price pose much bigger concerns going forward.
In its early days, Best Buy cashed in on consumers' hunger for electronics, music, and video games. But even as it put rival Circuit City into bankruptcy, the online revolution started pushing it down, as Amazon.com (Nasdaq: AMZN ) and its lower-priced alternatives ate into Best Buy's business. Best Buy still beats out smaller store-based businesses like RadioShack (NYSE: RSH ) and hhgregg (NYSE: HGG ) , but what has investors worried are the disappointing results it's put in lately.
But the company is trying to make strategic moves to counter the trends against big box retail. In 2010, it opened three times as many of its Best Buy Mobile stores than regular stores, looking to cash in on the popularity of Apple's (Nasdaq: AAPL ) iPhone and iPad as well as other products. In addition, Best Buy is trying to grab a bigger online presence. But having given Amazon such a huge head start, it's tough to see Best Buy catching up.
One possible avenue for growth may come from China. Although the company is closing all its namesake Chinese stores, its Five Star Appliance stores are better known in the emerging market country. Given how difficult a time other U.S. companies like Home Depot (NYSE: HD ) and Mattel (Nasdaq: MAT ) have had there, it's encouraging to see Best Buy thrive in China.
For Best Buy to start recovering, it needs to demonstrate that sales declines have hit bottom. If it can compete successfully with Amazon, there's an awful lot of upside for shareholders in the long run.
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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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."