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Has Diamond Foods Become the Perfect Stock?

By Dan Caplinger - Nov 27, 2012 at 9:40PM

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Finding companies that have all the right stuff can produce winners.

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 and then decide whether Diamond Foods (DMND.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.
  • Moneymaking 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 Diamond Foods.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

13.9%

Fail

 

1-Year Revenue Growth > 12%

8.9%

Fail

Margins

Gross Margin > 35%

18.8%

Fail

 

Net Margin > 15%

(5.1%)

Fail

Balance Sheet

Debt to Equity < 50%

163.4%

Fail

 

Current Ratio > 1.3

1.21

Fail

Opportunities

Return on Equity > 15%

(12.4%)

Fail

Valuation

Normalized P/E < 20

NM

NM

Dividends

Current Yield > 2%

1.3%

Fail

 

5-Year Dividend Growth > 10%

35.1%

Pass

       
 

Total Score

 

1 out of 9

Source: S&P Capital IQ. NM = not meaningful because of negative earnings. Total score = number of passes.

Since we looked at Diamond Foods last year, the company has lost 3 points, as plunging sales reversed year-ago profits to bring losses instead. The stock has also collapsed, falling 60% in the past year.

Diamond Foods was a relatively obscure snack-food company until last year, when it said it would acquire the Pringles potato chip line from Procter & Gamble (PG 1.36%). With Diamond's focus on nuts, dried fruit, and popcorn, the move would have helped it bolster its presence in the snack space by adding to its Kettle chip brand and potentially triple its revenues. Yet that deal fell through because of accounting problems, with Kellogg (K 2.50%) stepping in to pick up the Pringles prize, leaving Diamond to struggle on alone.

Since then, Diamond Foods has been dealing with those accounting problems. Earlier this month, the company's audit committee found that despite a lack of outright fraud, the company mistakenly pushed certain payments into later periods, making it hard to figure out correct measures of quarterly earnings. That, in turn, has caused a lack of confidence among suppliers, and Diamond is suffering much lower operating margins than PepsiCo (PEP 0.64%) and Kraft Foods (KRFT.DL) as a result.

Unfortunately, newly released financials make it far from clear whether Diamond can turn things around. It still has very strong market share in health-conscious segments of the snack-food industry, as if it can get its relationships with suppliers back on an even keel, it should be able to address margin concerns over time.

For Diamond to improve, it needs to get its accounting scandals behind it and start working on new plans for growth. Despite its challenges, Diamond has plenty of potential to get closer to perfection than it is today.

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 Diamond Foods to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

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Stocks Mentioned

Diamond Foods, Inc. Stock Quote
Diamond Foods, Inc.
DMND.DL
Kellogg Company Stock Quote
Kellogg Company
K
$70.18 (2.50%) $1.71
The Procter & Gamble Company Stock Quote
The Procter & Gamble Company
PG
$147.03 (1.36%) $1.98
Pepsico, Inc. Stock Quote
Pepsico, Inc.
PEP
$166.66 (0.64%) $1.06
Kraft Foods Group, Inc. Stock Quote
Kraft Foods Group, Inc.
KRFT.DL

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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