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Is Ralcorp the Perfect Stock?

Thursday - 11/29/2012, 6:56am  ET

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 Ralcorp 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 Ralcorp.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

14.1%

Fail

 

1-Year Revenue Growth > 12%

14.1%

Pass

Margins

Gross Margin > 35%

20.1%

Fail

 

Net Margin > 15%

1.7%

Fail

Balance Sheet

Debt to Equity < 50%

117.3%

Fail

 

Current Ratio > 1.3

2.15

Pass

Opportunities

Return on Equity > 15%

2.7%

Fail

Valuation

Normalized P/E < 20

62.66

Fail

Dividends

Current Yield > 2%

0%

Fail

 

5-Year Dividend Growth > 10%

0%

Fail

       
 

Total Score

 

2 out of 10

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

With just two points, Ralcorp doesn't look like a perfect stock. Shareholders likely agreed until very recently, as the shares traded roughly flat over the past year until a recent buyout bid sent shares soaring.

Ralcorp isn't a household name in itself, but it's the company behind a huge number of private-label brands that grocery store chains and other food retailers sell. Until this year, the company also produced brand-name Post cereals, but Ralcorp spun off that business into Post Holdings earlier this year.

The Post spinoff has done quite well, but Ralcorp itself has faced tough times. With the specter of food-price inflation looming over the entire industry, companies have had difficulty producing much organic growth. That has led to more merger and acquisition activity, such as Kellogg's deal to buy the Pringles snack unit from Procter & Gamble and ConAgra's purchase of privately held Del Monte Canada. Still, intense competition has prevented Ralcorp, Kellogg, and General Mills from freely passing on higher costs through to their customers.

But earlier this week, ConAgra finally succeeded in its long-held bid to buy out Ralcorp, agreeing to pay $90 per share for the food company. The deal follows past attempts from ConAgra to buy Ralcorp that proved unsuccessful.

With the deal likely to go through, investors may never see Ralcorp improve, but they will get a premium of about $20 per share over the price immediately preceding the takeover announcement. That's a nice pop for a stock that didn't look like it would become a perfect stock 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.

Regardless of what type of stocks you focus on, the best investing approach is to choose great companies and stick with them for the long term. In our free report "3 Stocks That Will Help You Retire Rich," we name 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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This article was originally published as Is Ralcorp the Perfect Stock?on Fool.com

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