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 E*TRADE Financial (Nasdaq: ETFC ) 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 E*TRADE Financial.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(7.7%)||Fail|
|1-Year Revenue Growth > 12%||46.3%||Pass|
|Margins||Gross Margin > 35%||88.8%||Pass|
|Net Margin > 15%||5.8%||Fail|
|Balance Sheet||Debt to Equity < 50%||199.7%||Fail|
|Current Ratio > 1.3||2.20||Pass|
|Opportunities||Return on Equity > 15%||1.7%||Fail|
|Valuation||Normalized P/E < 20||21.12||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||3 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
When we looked at E*TRADE Financial last year, it had a score of 4, so the company has slid a bit. A drop in normalized earnings has pushed the online broker's multiple above 20, despite poor performance from the stock since late 2010.
Times have been tough for discount brokers. In their most recent quarters, E*TRADE, Schwab (NYSE: SCHW ) , and TD AMERITRADE (Nasdaq: AMTD ) all saw average trades fall by double-digit percentages from last year's levels. That has once again raised the specter of consolidation within the industry.
But E*TRADE has its own unique problems. As a result of its foray into mortgage lending, the company has had to overcome delinquent loans. But like traditional lenders US Bancorp (NYSE: USB ) and SunTrust (NYSE: STI ) , E*TRADE has seen its delinquency rates continue to drop substantially.
Partly in response to pressure from hedge fund investor Citadel, which is E*TRADE's largest shareholder, E*TRADE has started to explore strategic alternatives -- Street-speak for putting itself up for sale. The logical buyer is TD Ameritrade, but so far, neither company has announced impending nuptials just yet.
Although it has made progress coming back from the financial crisis, E*TRADE has a lot of work to do to approach perfection. Before that happens, the company might well find itself the target of a hungry competitor.
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.
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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."