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 Chimera Investment Corp. (NYSE: CIM ) 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 Chimera.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-year annual revenue growth > 15%||NM||NM|
|1-year revenue growth > 12%||98.1%||Pass|
|Margins||Gross margin > 35%||100%||Pass|
|Net margin > 15%||91.6%||Pass|
|Balance sheet||Debt to equity < 50%||133.3%||Fail|
|Current ratio > 1.3||0.22||Fail|
|Opportunities||Return on equity > 15%||18.5%||Pass|
|Valuation||Normalized P/E < 20||10.41||Pass|
|Dividends||Current yield > 2%||16.6%||Pass|
|5-year dividend growth > 10%||6.0%*||Fail|
|Total Score||6 out of 9|
Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful; Chimera has existed less than five years. *Two-year dividend growth rate. Total score = number of passes.
The combination of low short-term interest rates and high spreads between short and long rates has stoked huge demand for companies that use leveraged investment strategies to buy mortgage securities. Annaly Capital (NYSE: NLY ) , American Capital Agency (Nasdaq: AGNC ) , and Anworth Mortgage Asset (NYSE: ANH ) have all become almost household names for investors who look through the lists of top-yielding dividend stocks, with their 10%+ payouts.
Unlike those REITs, however, Chimera specializes in mortgage securities that aren't backed by government agencies like Ginnie Mae, Fannie Mae, and Freddie Mac. In fact, Chimera was spun off from Annaly precisely to separate out non-agency-backed mortgage securities from Annaly's agency-backed portfolio.
You'll notice that Chimera uses a lot less leverage than traditional mortgage REITs, in part to compensate for the default risk of non-agency debt. But the benefit for shareholders is that Chimera is correspondingly less exposed to interest rate risk, so when short-term rates start to rise, Chimera may take a hit, but probably not as big a hit as its more leveraged cousins.
Chimera pays a great dividend, but if you think it's safe from risk, you're fooling yourself. Yet with such a high payout right now, it could remain a lucrative holding even if higher rates force it to cut its dividend in the future.
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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