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Is Ralcorp the Perfect Stock?

http://www.fool.com/investing/general/2012/11/28/is-ralcorp-the-perfect-stock.aspx

Dan Caplinger
November 29, 2012

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 Ralcorp (NYSE: RAH  ) 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 Ralcorp.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

14.1%

Fail

 

1-Year Revenue Growth > 12%

14.1%

Pass

Margins

Gross Margin > 35%

20.1%

Fail

 

Net Margin > 15%

1.7%

Fail

Balance Sheet

Debt to Equity < 50%

117.3%

Fail

 

Current Ratio > 1.3

2.15

Pass

Opportunities

Return on Equity > 15%

2.7%

Fail

Valuation

Normalized P/E < 20

62.66

Fail

Dividends

Current Yield > 2%

0%

Fail

 

5-Year Dividend Growth > 10%

0%

Fail

       
 

Total Score

 

2 out of 10

Source: S&P Capital IQ. Total score = number of passes.

With just two points, Ralcorp doesn't look like a perfect stock. Shareholders likely agreed until very recently, as the shares traded roughly flat over the past year until a recent buyout bid sent shares soaring.

Ralcorp isn't a household name in itself, but it's the company behind a huge number of private-label brands that grocery store chains and other food retailers sell. Until this year, the company also produced brand-name Post cereals, but Ralcorp spun off that business into Post Holdings (NYSE: POST  ) earlier this year.

The Post spinoff has done quite well, but Ralcorp itself has faced tough times. With the specter of food-price inflation looming over the entire industry, companies have had difficulty producing much organic growth. That has led to more merger and acquisition activity, such as Kellogg's (NYSE: K