Is Aqua America the Perfect Stock?

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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 Aqua America (NYSE: WTR  ) 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 Aqua America.

Factor What We Want to See Actual Pass or Fail?
Growth 5-Year Annual Revenue Growth > 15% 7.9% Fail
  1-Year Revenue Growth > 12% 7.9% Fail
Margins Gross Margin > 35% 61.5% Pass
  Net Margin > 15% 17% Pass
Balance Sheet Debt to Equity < 50% 134.6% Fail
  Current Ratio > 1.3 0.72 Fail
Opportunities Return on Equity > 15% 11% Fail
Valuation Normalized P/E < 20 25.85 Fail
Dividends Current Yield > 2% 2.6% Pass
  5-Year Dividend Growth > 10% 8.3% Fail
  Total Score   3 out of 10

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

With just three points, Aqua America doesn't look perfect. But in a world that gets thirstier every moment, even a boring-looking water utility could get exciting in a hurry.

Aqua is a regulated utility that provides water and wastewater services in the eastern U.S., primarily Pennsylvania. Its long-term strategy has been to buy up private and municipal water systems and then benefit from its efficiencies of scale. The company has bought out more than 200 acquisitions since 1995 and continued its buying binge last year.

The water-rich East may seem like a strange place to make money in water. Many focus on water-starved areas in the West, where California Water Service (NYSE: CWT  ) and American States Water (NYSE: AWR  ) have a strong presence. But Aqua has a huge cost advantage over those competitors, and it shows up clearly in its attractive net margins. Even though Aqua's return on equity doesn't meet our threshold, neither its Western competitors nor direct peer American Water Works (NYSE: AWK  ) can match it.

In addition, although Aqua's dividend doesn't lead the bunch, the company has grown its payout significantly in recent years. Again, although 8% dividend growth doesn't meet our 10% test, it's still good to see.

Aqua America faces the typical challenges of most utilities, including high debt levels and slow growth. But if you think water is only going to get more important to the U.S. economy, Aqua deserves some of your attention.

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.

Click here to add Aqua America to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Aqua America and California Water Service Group are Motley Fool Income Investor recommendations. The Fool owns shares of California Water Service Group. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 07, 2011, at 11:37 AM, prginww wrote:

    I own some of Aqua and think it is a great stock. The dividend is small but reliable and since I bought it a few years ago at about $16, I am quite happy with its current price.

    I would still buy it - I think it is a very solid company and (as the article said) water is going to become as precious as oil in the not so distant future.

  • Report this Comment On February 09, 2011, at 7:44 AM, prginww wrote:

    Thanks for sharing your thoughts, but I don't quite agree with your analysis on several points. Allow me to substantiate:

    1. Revenue Growth: Indeed growth is a great driver for potential value creation, but it needs to be assessed/analyzed in the context of the industry. One can't expect a utility company grow at 15%. Unlike software distribution there are hurdles (both organic and otherwise) that impede that growth. So for me 7.9% growth in STABLE revenues is quite a fantastic achievement!

    2. Debt/Equity: High debt to equity is bad only for companies which have volatile earnings. Leverage amplifies both positive and negative earnings so the more volatile the revenue the less the company should have debt (look at successful airlines as an example).

    Debt is quite good for equity holders in a company which has a very solid (i.e. not volatile) revenue line. It amplifies ROE.

    3. Money making opportunities: Although this could (and most likely would) be improved the ROE figure is only a reflection of risks an investor is taking. It would be hard to sustain an ROE north of 15% in a regulated industry, because regulators would indeed cut their tariffs in the long run. The beta of the stock has been 0.2 while it's ROE is in line with market 11%. Personally such a high quality ROE is more than enough for the risks I am taking.

    4. Valuation: now I agree here that valuation is high in absolute values, but again if you think about the stable dividend growth the company has provided over many years, it's margins and it's expansion plans, it may very well be justified.

    Last but not least, I believe in the management of the company. They are people with passion for their industry and a strong willingness to be a leader in the industry. The company has the highest market cap among peers and is expected to growth further and I think they haven't even scratched the surface.

    For all of the above reasons, WTR is a perfect stock for my portfolio!!!

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