Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?
One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Charles Schwab (NYSE: SCHW ) fits the bill.
The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.
Some of the most basic yet important things to look for in a stock are:
- 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 don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
- Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
- Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
- Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. 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.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-year annual revenue growth > 15%||3.3%||Fail|
|1-year revenue growth > 12%||2.1%||Fail|
|Margins||Gross margin > 35%||100%||Pass|
|Net margin > 15%||10.7%||Fail|
|Balance sheet||Debt to equity < 50%||33.3%||Pass|
|Current ratio > 1.3||0.60||Fail|
|Opportunities||Return on equity > 15%||8.2%||Fail|
|Valuation||Normalized P/E < 20||27.40||Fail|
|Dividends||Current yield > 2%||1.3%||Fail|
|5-year dividend growth > 10%||21.9%||Pass|
|Total Score||3 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Schwab's score of three isn't perfect. But the company that revolutionized the brokerage industry has made some interesting moves in the last year or so.
The world of online brokers may seem like a pretty boring place. But lately, it's been the battleground for an intense price war. Schwab fired the opening shot in late 2009 by cutting commissions and offering a new line of free exchange-traded funds. In the ensuing months, Fidelity, Vanguard, and most recently TD AMERITRADE (Nasdaq: AMTD ) responded with similar free-ETF deals.
So far, the move has done a good job of bringing assets to Schwab. In 2010, Schwab's ETFs gathered $2.1 billion in assets, which is an excellent start in what's becoming a cutthroat industry.
Unfortunately, not everything has gone Schwab's way. The company had to pay a $118 million fine to the Securities and Exchange Commission for misleading investors about its YieldPlus short-term bond fund. While the company is performing better financially than struggling E*TRADE Financial (Nasdaq: ETFC ) and Interactive Brokers (Nasdaq: IBKR ) , both of which have lost money over the past 12 months, Schwab's margins and return on equity are much lower than TD AMERITRADE.
Schwab has a strong brand that it has used to gain a foothold in the ETF industry. Nevertheless, despite its good reputation, it seems unlikely that Schwab will turn slow growth, low net margins, and weak financial performance into perfection in the years to come.
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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