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 Charles Schwab (NYSE: SCHW ) 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 Schwab.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||1.7%||Fail|
|1-Year Revenue Growth > 12%||10.4%||Fail|
|Margins||Gross Margin > 35%||100%||Pass|
|Net Margin > 15%||18.4%||Pass|
|Balance Sheet||Debt to Equity < 50%||26.0%||Pass|
|Current Ratio > 1.3||0.49||Fail|
|Opportunities||Return on Equity > 15%||12.4%||Fail|
|Valuation||Normalized P/E < 20||17.57||Pass|
|Dividends||Current Yield > 2%||1.9%||Fail|
|5-Year Dividend Growth > 10%||12.2%||Pass|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Schwab last year, the online broker has seen its score rise by two points, with its valuation falling to more reasonable levels and its net margins on the rise. But the past year has been a tough one on the stock, which has faced a difficult environment for the brokerage industry overall.
Schwab relies on mainstream investors, and they've largely been afraid of the stock market ever since the 2008 financial crisis. In its latest quarterly report, Schwab saw drops in all of its major segments compared to the previous quarter. That jibes with what rival TD AMERITRADE (Nasdaq: AMTD ) saw, with average trade volume falling during the fourth quarter. E*TRADE Financial (Nasdaq: ETFC ) reported even uglier results, with a quarterly loss and a 7% year-over-year drop in trade volume combined with fewer new account openings.
The company has seen some growth on the banking side of its business. That makes some sense, especially as savvy investors move money away from money market mutual funds and toward higher-yielding bank accounts that also enjoy FDIC insurance protection. Given that Schwab has had to waive some of its own money market fees recently, having a bank affiliate allows the company to hold onto assets that might otherwise go elsewhere.
Longer-term, Schwab has a huge opportunity to tap into anti-Wall Street sentiment to poach clients away from Goldman Sachs (NYSE: GS ) and Morgan Stanley (NYSE: MS ) , each of which has seen its own struggles recently. Goldman had a big drop in earnings and revenue in its fourth quarter, while Morgan Stanley reversed a year-ago profit with a loss. If Schwab can eat into the two companies' market share, it could get a lot closer to perfection in the years ahead.
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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