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 Lumber Liquidators (NYS: LL) 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 Lumber Liquidators.
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.
Lumber Liquidators hasn't built a perfect record with a score of only 4. The hardwood flooring specialist took the industry by storm posting strong sales growth even during the depths of the recession, but a recent slowdown shocked investors.
Lumber Liquidators differentiates itself from other home-targeting retailers Home Depot (NYS: HD) and Lowe's (NYS: LOW) by drilling down on one specialized area. Yet by avoiding Builders FirstSource's strategy of relying on new residential construction for business, Lumber Liquidators has tried to capitalize on the same trend as big-box home improvement retailers.
Until recently, Lumber Liquidators was doing an excellent job. New stores were relatively inexpensive to open, and typical stores recouped their initial investment within a single year. With plans for expansion, the future looked bright for the company.
Last month, though, Lumber Liquidators shares took a 30% hit in just one day as the company cut its sales guidance for the year. Although that makes the shares a compelling value, the housing market is still continuing to drop. Deck makerTrex (NAS: TREX) has also seen huge declines in its business. As long as millions of homeowners are underwater on their mortgages, they won't have the same incentive to upgrade their homes -- and that will cost Lumber Liquidators some badly needed business.
Investors need to see Lumber Liquidators regain its former growth trajectory in order to justify its valuation. That's certainly possible if the economy doesn't turn back downward. But until management regains confidence about the future, Lumber Liquidators won't be a perfect 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 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. The Motley Fool owns shares of Lumber Liquidators.Motley Fool newsletter serviceshave recommended buying shares of Home Depot, Lowe's, and Lumber Liquidators, as well as writing covered calls on Lowe's. 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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