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 Lorillard Inc. (NYSE:LO) 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 the 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 Lorillard Inc. (NYSE:LO).
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Growth | 5-year annual revenue growth > 15% | 7.2% | Fail |
| 1-year revenue growth > 12% | 4.1% | Fail | |
| Margins | Gross margin > 35% | 51.4% | Pass |
| Net margin > 15% | 23.7% | Pass | |
| Balance sheet | Debt to equity < 50% | NM | NM |
| Current ratio > 1.3 | 1.73 | Pass | |
| Opportunities | Return on equity > 15% | NM | NM |
| Valuation | Normalized P/E < 20 | 13.58 | Pass |
| Dividends | Current yield > 2% | 5.3% | Pass |
| 5-year dividend growth > 10% | 13.9% | Pass | |
| Total score | 6 out of 8 |
Source: S&P Capital IQ. NM = not meaningful due to negative shareholder equity. Total score = number of passes.
Since we looked at Lorillard last year, the company has kept its six-point score for the third year in a row. The stock hasn’t been as fortunate, though, falling by nearly 10% over the past year.
Lorillard Inc. (NYSE:LO) has faced the same overall negative trends that the entire tobacco industry has had to deal with over the decades. Between high taxes and health concerns, cigarette smoking has fallen sharply since the 1960s, and even a brief spike of smoking among students in the 1990s has reversed itself over the past decade.
But even after winning a case alongside Reynolds American, Inc. (NYSE:RAI) to strike down an FDA requirement that cigarette manufacturers make packaging changes that include more prominent warnings and graphic images, Lorillard still faces intense anti-smoking campaigns from the CDC through public service announcements. The impact has been significant, as Lorillard Inc. (NYSE:LO)’s shipment volume fell 1.4% last year and Reynolds posted a 2.3% decline, matching the overall industry’s drop.
Still, Lorillard Inc. (NYSE:LO) has managed to avoid some of the worst of the damage. Reynolds and Altria Group Inc (NYSE:MO) both announced layoffs over the past couple of years in response to sales declines. Lorillard has managed to maintain an advantage over Altria Group Inc (NYSE:MO) by selling both premium and discounted brands, catering both to high-end customers and those struggling to afford cigarettes at all. What’s particularly impressive is that Lorillard has done so while still keeping its margins nearly as high as Altria Group Inc (NYSE:MO)’s, despite Altria’s greater reliance on premium brands.
For Lorillard to improve, it needs to win smokers from competing brands. Without that revenue boost, Lorillard likely won’t ever get the final points it needs to reach perfection.
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.
The article Has Lorillard Become the Perfect Stock? originally appeared on Fool.com and is written by Dan Caplinger.
Fool contributor Dan Caplinger has no position in any stocks mentioned, and neither does The Motley Fool.
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