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 Cherokee
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 Cherokee.
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Growth | 5-year annual revenue growth > 15% | (5.6%) | Fail |
| 1-year revenue growth > 12% | (0.5%) | Fail | |
| Margins | Gross margin > 35% | 100% | Pass |
| Net margin > 15% | 34.8% | Pass | |
| Balance sheet | Debt to equity < 50% | 0% | Pass |
| Current ratio > 1.3 | 2.50 | Pass | |
| Opportunities | Return on equity > 15% | 56.7% | Pass |
| Valuation | Normalized P/E < 20 | 14.73 | Pass |
| Dividends | Current yield > 2% | 7.8% | Pass |
| 5-year dividend growth > 10% | (5.3%) | Fail | |
| Total Score | 7 out of 10 |
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With seven points, Cherokee looks pretty good. Much of its success comes from its unusual business model, which milks value from brand names without having to actually manufacture any products.
What Cherokee does is to act as a go-between for brand owners and retailers. Cherokee licenses brand-name rights to major retailers, which are then responsible for manufacturing and marketing products. Target
Unfortunately, Cherokee got hit hard by the recession. Revenue fell sharply, and even though its current return on equity of 56% looks attractive, it was actually much higher in previous years. After years of dividend hikes, the company had to rein in payouts.
As the economy recovers, though, Cherokee could return to its winning ways. Compared with competitor Iconix Brand Group
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.
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