Has Dollar Tree Become the Perfect Stock?

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 Dollar Tree 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 Dollar Tree.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

11.8%

Fail

 

1-year revenue growth > 12%

11.5%

Fail

Margins

Gross margin > 35%

35.9%

Pass

 

Net margin > 15%

8.4%

Fail

Balance sheet

Debt to equity < 50%

16.3%

Pass

 

Current ratio > 1.3

2.18

Pass

Opportunities

Return on equity > 15%

41.1%

Pass

Valuation

Normalized P/E < 20

17.15

Pass

Dividends

Current yield > 2%

0%

Fail

 

5-year dividend growth > 10%

0%

Fail

       
 

Total score

 

5 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Dollar Tree last year, the company hasn't been able to regain the point it lost from 2011 to 2012. The shares have also struggled, just barely managing to claw back to break-even over the past year.

Throughout much of the slow recovery in the economy in the past several years, deep-discount retailers have performed exceedingly well. By selling low-cost but high-margin merchandise, Dollar Tree and rivals Family Dollar and Dollar General have managed to carve out a highly lucrative niche for themselves, taking away business from slightly higher-end discounters Wal-Mart and Target.

But aggressive expansion plans from Dollar General and Family Dollar have raised the threat of a saturated market for deep discounters, and that has kept their shares down recently. Moreover, macroeconomic effects from high gas prices and the reimposition of the full Social Security payroll tax at the beginning of 2013 have reduced the amount of disposable income that Dollar Tree's core shoppers have to spend, and that could continue to have an impact on revenue and profitability going forward.

In its most recent quarter, Dollar Tree managed to top analyst expectations on both revenue and earnings, posting a 2.4% increase in same-store sales, and managing to show substantial improvement on its operating margins. Even though the company's 2013 guidance fell somewhat short of the consensus among those following the stock, Dollar Tree's stock soared as investors gave a sigh of relief that things weren't far worse.

For Dollar Tree to improve, it needs to hope for just the right combination of sluggish economic growth to keep its customers both able to spend, but unable to upgrade to higher-end retailers. Unless it can manage that balancing act, Dollar Tree could continue to face challenging times ahead.

Keep searching
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.

Click here to add Dollar Tree to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

The article Has Dollar Tree Become the Perfect Stock? originally appeared on Fool.com.

Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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