Has Cato Become the Perfect Stock?

Before you go, we thought you'd like these...
Before you go close icon

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 (NYS: 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.

Factor

What We Want to See

Actual

Pass or Fail?

Growth5-Year Annual Revenue Growth > 15%1.4%Fail
 1-Year Revenue Growth > 12%(0.3%)Fail
MarginsGross Margin > 35%38.5%Pass
 Net Margin > 15%7.1%Fail
Balance SheetDebt to Equity < 50%0%Pass
 Current Ratio > 1.32.78Pass
OpportunitiesReturn on Equity > 15%17.6%Pass
ValuationNormalized P/E < 2012.61Pass
DividendsCurrent Yield > 2%3.5%Pass
 5-Year Dividend Growth > 10%8.9%Fail
    
 Total Score 6 out of 10

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

Since we looked at Cato last year, the company has kept its six-point score. But the stock has held up a lot better than some of its retail peers.

Cato is a women's clothing retailer with an unusual focus. Rather than following the model that Chico's FAS (NYS: CHS) and Talbots (NYS: TLB) have used to try to compete for high-end shoppers, Cato instead tends to serve smaller markets with stores in strip malls and other less-expensive locations.

That may not sound like a lucrative business model, but Cato has turned it into profits over the years, with a tendency to raise dividends, too. Just last quarter, the company boosted its payout by 8% to an even $1 per share annually. Chico's has also managed to up its dividend this year, but both Talbots and ANN (NYS: ANN) don't pay dividends at all.

But recently, Cato hasn't delivered the results investors want to see. For June, same-store sales fell 10%, and the company said that earnings would come in at the low end of its previous guidance. If that trend continues, Cato's stock won't be able to hold up as well as it has.

For Cato to improve, it needs to reverse the troubling trend of lower same-store sales. In the fickle world of apparel retail, that's always a tough order, but Cato made it through the long recession over the past several years and should have what it takes to succeed this time around as well.

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.

Cato isn't the perfect stock, but we've got some ideas you may like better. Let me invite you to learn about three smart long-term stock plays in The Motley Fool's latest special report. It's yours for the taking and is absolutely free, but don't miss out -- click here and read it today.

Click hereto add Cato to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

At the time this article was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Cato. 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.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners