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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 FirstEnergy (NYSE: FE ) 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 FirstEnergy.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||1.8%||fail|
|1-Year Revenue Growth > 12%||(1.1%)||fail|
|Margins||Gross Margin > 35%||49.9%||pass|
|Net Margin > 15%||6.6%||fail|
|Balance Sheet||Debt to Equity < 50%||168.6%||fail|
|Current Ratio > 1.3||0.68||fail|
|Opportunities||Return on Equity > 15%||9.7%||fail|
|Valuation||Normalized P/E < 20||13.90||pass|
|Dividends||Current Yield > 2%||6.2%||pass|
|5-Year Dividend Growth > 10%||5.7%||fail|
|Total Score||3 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
FirstEnergy's score of 3 leaves it well short of perfect. But the utility company resembles many of its peers on most of these measures.
FirstEnergy generates and transmits electricity in Ohio, New Jersey, and Pennsylvania. Like fellow electric utilities Southern Company (NYSE: SO ) and PG&E (NYSE: PCG ) , FirstEnergy requires substantial capital that it generates from debt financing. As a result, debt-to-equity levels are high for these companies, yet returns on equity are limited by regulated rates.
Unfortunately, the company has seen most of its financials move in the wrong direction. FirstEnergy has had increasing debt and falling gross margins in recent years, and nervous investors have responded by letting the stock's multiple to earnings fall and by maintaining a relatively high level of short interest.
FirstEnergy's primary attraction to investors is its dividend, which is even higher than high-yielders Duke Energy (NYSE: DUK ) and Exelon (NYSE: EXC ) . In order to get investors' attention, FirstEnergy needs to find ways to boost revenue and translate its superior gross margins into net profit. If it does so, FirstEnergy could find itself among the top tier of utility stocks, even if it never reaches perfect status.
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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