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 Dollar General Corp. (NYSE:DG) 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 Dollar General.
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Growth | 5-year annual revenue growth > 15% | 11% | Fail |
| 1-year revenue growth > 12% | 8.2% | Fail | |
| Margins | Gross margin > 35% | 31.7% | Fail |
| Net margin > 15% | 5.9% | Fail | |
| Balance sheet | Debt to equity < 50% | 55.7% | Fail |
| Current ratio > 1.3 | 1.54 | Pass | |
| Opportunities | Return on equity > 15% | 19.7% | Pass |
| Valuation | Normalized P/E < 20 | 17.69 | Pass |
| Dividends | Current yield > 2% | 0% | Fail |
| 5-year dividend growth > 10% | 0% | Fail | |
| Total score | 3 out of 10 |
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Dollar General last year, the company has given back one of the two points it gained from 2011 to 2012. The stock has held its own fairly well, rising between 5% and 10% over the past year.
The low end of the retail chain has been a good place for many companies lately, as continued worries about the strength of the economic recovery have kept customers going to discounters. Dollar General has done its best to hold off rising competition by aggressively expanding, with plans to open more than 600 new stores this year.
The fiscal cliff debate at the beginning of the year, however, hit low-income shoppers hardest, as the disappearance of temporary payroll tax reductions increased withholding and reduced take-home pay for workers of all income levels. The resulting decline had Wal-Mart Stores, Inc. (NYSE:WMT) asking where all of its customers had gone, as it issued cautious guidance about the current quarter. Similarly, just last week, teen-discounter Five Below Inc (NASDAQ:FIVE) announced strong past results but forecast weaker guidance for the current quarter, sending shares downward on fears that its growth might not be sustainable.
Yet Dollar General Corp. (NYSE:DG) hasn’t seen those pressures yet. In its most recent quarterly earnings report, Dollar General managed to set record highs for the fourth quarter and the full 2012 year in terms of revenue, net profit, and earnings per share. The company also said that it expects year-over-year sales growth of 10% to 12%, with similar percentage gains in earnings per share as well.
For Dollar General Corp. (NYSE:DG) to improve, it needs its expansion to produce not just higher revenue but also better margins and earnings growth. Otherwise, the Dollar General Corp. (NYSE:DG) store may never get much closer to 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 Dollar General Become the Perfect Stock? originally appeared on Fool.com is written by Dan Caplinger.
Fool contributor Dan Caplinger and The Motley Fool have no position in any of the stocks mentioned.
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