Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Spectra Energy (NYSE: SE ) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- 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 mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. 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 Spectra Energy.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||3.3%||Fail|
|1-Year Revenue Growth > 12%||9.0%||Fail|
|Margins||Gross Margin > 35%||54.5%||Pass|
|Net Margin > 15%||22.3%||Pass|
|Balance Sheet||Debt to Equity < 50%||118.5%||Fail|
|Current Ratio > 1.3||0.89||Fail|
|Opportunities||Return on Equity > 15%||14.2%||Fail|
|Valuation||Normalized P/E < 20||16.91||Pass|
|Dividends||Current Yield > 2%||3.9%||Pass|
|5-Year Dividend Growth > 10%||3.8%||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
When we looked at Spectra Energy last year, it had the same score of four. But the company has made some small progress, with revenue growth picking up somewhat in the past year, and improvement in margins, debt levels, and valuation also helping.
Spectra Energy is the natural gas pipeline and storage spinoff from Duke Energy (NYSE: DUK ) , which set Spectra free in 2007. That turned out to be great timing for Duke but bad timing for Spectra shareholders, who saw the stock lose half its value during the financial crisis.
But shares have bounced back with a vengeance. Even though low natural gas prices hurt producers, new natural gas development presents a big growth opportunity for pipeline companies.
Realizing this, the big players in the industry are starting to make big strategic moves to cash in. Earlier this week, Kinder Morgan (NYSE: KMI ) announced it would buy El Paso Corp. (NYSE: EP ) for $21.1 billion, which would help Kinder Morgan beat out Enterprise Products Partners (NYSE: EPD ) as the largest U.S. pipeline company. Meanwhile, Energy Transfer Equity (NYSE: ETE ) sold its propane segment to Amerigas Partners (NYSE: APU ) for $2.8 billion in order to focus on its gas transportation business, and earlier this summer won a bidding war against Williams Companies (NYSE: WMB ) to pick up Southern Union and its pipeline network in the Southeast.
How Spectra will respond to this frenzy remains to be seen. With only around $500 million in cash against more than $11 billion in debt, it's questionable whether the company would want to go to the effort of raising capital to make a deal.
It's increasingly clear, though, that in a big industry ramp-up, the key to perfection is growth. Spectra may want to take the financial gamble of an M&A move in order to avoid getting left behind. If it succeeds, it could get a lot closer to perfection in the near future -- especially if gas prices finally start to rise.
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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