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 Smith & Wesson 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 Smith & Wesson.
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 Smith & Wesson last year, the company has doubled its score, as soaring earnings have brought its valuation down, and its margins and returns on equity up. The company has also improved its balance sheet, and the stock has risen more than 40% over the past year.
Throughout the past year, gun demand has been extremely strong, and higher profits have boosted share prices throughout the industry. In early 2012, Sturm Ruger even had to stop taking new orders briefly because it was so overwhelmed by customer demand, and while Smith & Wesson never reached quite that level of order activity, it, too, benefited from the trend.
More recently, though, the renewal of gun-control concerns has had a mixed reaction on Smith & Wesson. Immediately after the tragic events in Connecticut in December, the company's shares plunged on fears that new legislation would limit gun sales. Yet, since then, the stock has made a strong recovery, as those initial concerns appear to have been overblown as any new regulation is likely to be fairly limited in scope.
In its most recent quarter, Smith & Wesson more than tripled its year-ago earnings per share on a nearly 40% increase in revenue. Yet, even projections of a similar rise in 2013 weren't enough to satisfy investors, as the stock fell on the announcement two weeks ago.
For Smith & Wesson to keep improving, it needs to build on its revenue surge, and work at keeping its margins up. If the run continues, then paying a dividend is the next logical step toward becoming 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.
The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report, "3 Stocks That Will Help You Retire Rich," names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.
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The article Has Smith & Wesson Become the Perfect Stock? originally appeared on Fool.com.
Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of Sturm Ruger. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.
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