Is National Grid the Perfect Stock?

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 whether National Grid (NYSE: NGG  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. 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 that a company can 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 National Grid.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

14.3%

fail

 

1-Year Revenue Growth > 12%

(10.5%)

fail

Margins

Gross Margin > 35%

68.3%

pass

 

Net Margin > 15%

9.9%

fail

Balance Sheet

Debt to Equity < 50%

598.3%

fail

 

Current Ratio > 1.3

0.77

fail

Opportunities

Return on Equity > 15%

33.9%

pass

Valuation

Normalized P/E < 20

8.92

pass

Dividends

Current Yield > 2%

7.1%

pass

 

5-Year Dividend Growth > 10%

10.2%

pass

 

Total Score

 

5 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

A score of 5 definitely isn't perfect, but for a utility, it's pretty good. National Grid actually comes very close to getting an extra point for long-term revenue growth, since it's been growing at a faster clip than competitors Duke Energy (NYSE: DUK  ) and Southern Company (NYSE: SO  ) over the past five years. However, National Grid's balance sheet is far more leveraged than those two utilities, although none of them meets the 50% debt-to-equity threshold we like to see.

One reason investors have been hesitant about National Grid is that it raised capital recently, diluting existing shareholders, after saying it wouldn't. But the company has a high dividend yield, while trading at a normalized earnings multiple that's even cheaper than Inside Value pick Exelon (NYSE: EXC  ) . So even if National Grid may not be perfect, it's worth a look if you're seeking reliable dividend income at a reasonable price.

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.

The Motley Fool is recommending 50 stocks in 50 days for its new "11 O'Clock Stock" series. For more information, click here. Then come back to Fool.com every single weekday at 11 a.m. ET for a brand-new pick!

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. 

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Duke Energy, National Grid, and Southern Company are Motley Fool Income Investor recommendations. The Fool owns shares of Exelon, which is a Motley Fool Inside Value selection. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


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  • Report this Comment On September 28, 2010, at 10:35 AM, ETFsRule wrote:

    It's also important to look at the magnitude of each of these characteristics - a pass/fail grade is not always enough. The one that jumps out here is their debt/equity - it's much too high. Even if they had passing grades in every other category, I still could not buy this stock. It's too risky to invest in a company with such an astronomical level of debt.

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