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Has Heinz Become the Perfect Stock?

Sunday - 2/17/2013, 2:00am  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 and then decide whether Heinz fits the bill, especially in light of the buyout bid it recently received.

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 Heinz.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

4.2%

Fail

 

1-year revenue growth > 12%

3.2%

Fail

Margins

Gross margin > 35%

35.7%

Pass

 

Net margin > 15%

8.7%

Fail

Balance sheet

Debt to equity < 50%

171.4%

Fail

 

Current ratio > 1.3

1.18

Fail

Opportunities

Return on equity > 15%

35.1%

Pass

Valuation

Normalized P/E < 20

27.08

Fail

Dividends

Current yield > 2%

2.9%

Pass

 

5-year dividend growth > 10%

6.4%

Fail

       
 

Total score

 

3 out of 10

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

With just a 3-point score, Heinz doesn't look particularly remarkable by these criteria. But Warren Buffett thinks the company is a lot closer to perfection, and the shares have soared almost 40% in the past year, with most of that having come in the past week.

Until recently, Heinz drew relatively little attention despite its slow but steady gains throughout 2012. Most investors saw Heinz as a slow-growth business with relatively little potential, and many saw Unilever as offering better prospects for expansion with its combination of food and personal-care products giving it more diversification than Heinz. The sluggishness of the food industry generally, which has faced food-inflation price pressures for a while now, was a big part of why Kraft Foods split off its higher-growth international snack business from its North American grocery segment.

But last week, Berkshire Hathaway and private-equity firm 3G Capital made a surprise bid for Heinz, bidding $72.50 per share for the company. Some analysts believe that Buffett may have overpaid for Heinz. But the deal's structure puts much of the risk on 3G, as Berkshire will get an equal common-stock position but also own preferred shares worth $8 billion that will pay a 9% annual dividend. In Buffett's words, "Heinz will be 3G's baby," and with the overhang of preferred stock, the deal from 3G's perspective will closely resemble a highly leveraged buyout transaction.

With little chance that the transaction will be rejected, Heinz may not have much chance to improve before exiting the market as a public company. But you can count on having 3G and Berkshire work to reduce debt and use the iconic brand to drive sales growth in emerging markets like 3G's native Brazil. Whatever happens, you haven't heard the last of Heinz.

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