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 American Eagle Outfitters (NYS: AEO) 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 American Eagle Outfitters.
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%
6 out of 10
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
American Eagle weighs in with a score of six points. The retailer has to navigate the same tough waters as a host of competitors, but what makes it stand out is its generous payout to shareholders.
American Eagle is part of a huge group of retailers catering to teens, many of which have faced difficulties recently. With Aeropostale (NYS: ARO) , Abercrombie & Fitch (NYS: ANF) , and Rue21 (NYS: RUE) all hitting kid shoppers at different price points, American Eagle has struggled over the past few years to get a true turnaround going.
In the meantime, though, American Eagle is lagging the pack. Its revenue shrunk last year, even as its competitors saw at least modest growth. Its return on equity has languished alongside Abercrombie's, but well beneath Rue21 and Aeropostale.
Despite these concerns, the one place where American Eagle shines is with its dividend, with a yield approaching 4% and strong double-digit annual dividend growth over the past five years. In addition, the stock trades at a cheap valuation, making those who believe a turnaround is imminent feel better about investing.
American Eagle isn't perfect, and many investors might feel more comfortable waiting for the revenue turnaround to take fuller shape before committing their money. If the retailer can regain its fashion sense, though, then American Eagle could quickly become a much more attractive stock.
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 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. The Motley Fool owns shares of Aeropostale. 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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