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 99 Cents Only Stores (NYS: NDN) 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 99 Cents Only Stores.
What We Want to See
Pass or Fail?
5-Year Annual Revenue Growth > 15%
1-Year Revenue Growth > 12%
Gross Margin > 35%
Net Margin > 15%
Debt to Equity < 50%
Current Ratio > 1.3
Return on Equity > 15%
Normalized P/E < 20
Current Yield > 2%
5-Year Dividend Growth > 10%
4 out of 10
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With just four points, 99 Cents Only doesn't seem to give investors as big a bargain as the company's retail customers get. But with the company the subject of takeover speculation, fundamentals no longer play a key role in what happens with 99 Cents Only.
During the recession in 2008, deep discount stores were one of the only safe havens in the stock market. Family Dollar (NYS: FDO) and Ross Stores (NAS: ROST) salvaged gains out of one of the worst bear markets in generations, and 99 Cents Only gained 37% during 2008.
Perhaps because of their success, deep discounters have gotten a lot of attention from buyout firms lately. Trian Fund Management bid on Family Dollar earlier this year, raising questions about whether Dollar General (NYS: DG) and Dollar Tree (NAS: DLTR) would get similar offers.
Meanwhile, 99 Cents Only got a bid of $19.09 per share from Leonard Green & Partners, but reports suggest that Apollo Global Management may make a higher offer for the company. That sent shares up as much as 10% yesterday, and a better bid could make shareholders a pretty penny in quick order.
Razor-thin margins and modest returns on equity are largely unique to 99 Cents Only, as its peers tend to have better financials. As a result, the best route to perfection for shareholders is likely through a private equity buyout. Without it, other deep discounters look a lot more like perfect stocks than 99 Cents Only does.
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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At the time thisarticle was published Fool contributorDan Caplingerdoesn't own shares of the companies mentioned in this article. 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 adisclosure policy.
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