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.
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: 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.
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 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.
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