Has Office Depot 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 and then decide whether Office Depot 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.
  • Moneymaking 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 Office Depot.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

(7.2%)

Fail

 

1-year revenue growth > 12%

(6.9%)

Fail

Margins

Gross margin > 35%

30.4%

Fail

 

Net margin > 15%

(0.7%)

Fail

Balance sheet

Debt to equity < 50%

62.9%

Fail

 

Current ratio > 1.3

1.32

Pass

Opportunities

Return on equity > 15%

(7.2%)

Fail

Valuation

Normalized P/E < 20

25.04

Fail

Dividends

Current yield > 2%

0%

Fail

 

5-year dividend growth > 10%

0%

Fail

       
 

Total score

 

1 out of 10

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

Since we looked at Office Depot last year, the company has given back the point it earned from 2011 to 2012. But investors haven't been unhappy with Pinnacle's performance, as the stock is up about 20% over the past year.

Office-supply store chains have been struggling lately, with a weak economy that has especially affected the small businesses that tend to be their biggest customers. As a result, Office Depot and its peers have found themselves fighting over pieces of a shrinking pie, with OfficeMax having seen similar revenue contraction over the past five years and even Staples suffering sales declines last year.

Those woes led Office Depot and OfficeMax to announce a merger of equals last week, with Office Depot to be the surviving company and OfficeMax investors to get 2.69 shares of Office Depot stock for each OfficeMax share they own. The companies hope to save $400 million to $600 million in costs annually within three years of the merger, but the synergies are likely to involve store closures in areas where both chains compete. Some analysts have noted that Staples may end up being a big winner from the move, as Office Depot and OfficeMax customers frustrated with store closures may flee to their rival. That explains the big gains in Staples' stock when the merger plans became public.

For Office Depot to improve, it needs the merger to be successful in rescuing revenue and cutting costs. With the companies not expecting a completed deal until much later in 2013, Office Depot isn't going to get much closer to perfection anytime soon.

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.

To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.

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

The article Has Office Depot 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 Staples. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


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