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 Cato (NYSE: CATO) 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 Cato.


What We Want to See


Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 2% Fail
  1-Year Revenue Growth > 12% 3.6% Fail
Margins Gross Margin > 35% 38.7% Pass
  Net Margin > 15% 6.7% Fail
Balance Sheet Debt to Equity < 50% 0% Pass
  Current Ratio > 1.3 2.68 Pass
Opportunities Return on Equity > 15% 18.9% Pass
Valuation Normalized P/E < 20 13.14 Pass
Dividends Current Yield > 2% 3.3% Pass
  5-Year Dividend Growth > 10% 7.3% Fail
  Total Score   6 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

With six points, Cato may not be perfect, but it puts much of the retail industry to shame. Nevertheless, Cato faces many of the same challenges that less successful retailers have struggled with lately.

Cato is a specialty retailer selling women's fashions. Unlike competitors Talbots (NYSE: TLB), Chico's (NYSE: CHS), and Coldwater Creek (Nasdaq: CWTR), however, Cato took a value-based approach to the recent recession. That has proven to be the right move, as in-fighting among higher-end retailers has led to some real train wrecks in the industry. Cato has managed to maintain better returns on equity than either of those three competitors, more from maintaining margins than through significant growth.

But things aren't perfect even for Cato. Just yesterday, the retailer disappointed investors by reporting same-store sales that rose just 1% during the five weeks that ended last Friday. Even more concerning was company guidance suggesting that higher costs for materials and freight charges would continue to weigh on earnings.

Before yesterday, Cato's shares were trading at new all-time highs, despite trading at a reasonable multiple to earnings. The question is whether the bad report was a one-time blip or a sign of worse things to come. But with a dividend yield well above 3%, if you have to pick a retail stock for your portfolio, you could certainly do worse than Cato.

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 Cato 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. 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.