Has Family Dollar Become the Perfect Stock?

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 Family Dollar (FDO.DL) 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 Family Dollar.

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

Since we looked at Family Dollar last year, the company hasn't been able to regain the point it lost from 2010 to 2011. But the stock has done pretty well, rising about 20% over the past year.

Family Dollar's business model is easy to understand. Along with peers Dollar General (DG -0.41%) and Dollar Tree (DLTR 0.04%), Family Dollar strives to carry low-end inventory and sell it at attractive prices that nevertheless include huge markups. During the previous recession, that business model was extremely successful, as cash-strapped shoppers looked for any edge they could get and vaulted the deep-discount retail segment into the limelight in a major way.

The problem with Family Dollar, though, is that competitors have figured out its strategy and are moving to take on the company head-on. With industry peer Big Lots (BIG) and even drugstore retailer CVS Caremark (CVS -0.22%) taking steps to try to capture the highest-margin business that sustains dollar-store profitability, Family Dollar will face an increasingly difficult road ahead to try to maintain the current favorable conditions in the retail industry that have made it so successful.

In its most recent quarter, Family Dollar posted extremely promising sales and earnings gains, with comparable store sales growing 5.4% and earnings rising strongly. Yet analysts still fear that without sustained economic weakness, Family Dollar won't be able to grab new customers from rival chains targeting higher price points, and therefore that growth will be subdued going forward.

To improve, Family Dollar would benefit from a new economic slowdown. Yet with shares priced at fairly high levels, investors seem already to be anticipating ongoing weakness, making Family Dollar a speculative play going forward.

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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