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 Aqua America (NYSE: WTR ) 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 Aqua America.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||7.6%||Fail|
|1-Year Revenue Growth > 12%||9.9%||Fail|
|Margins||Gross Margin > 35%||62.5%||Pass|
|Net Margin > 15%||18.4%||Pass|
|Balance Sheet||Debt to Equity < 50%||132%||Fail|
|Current Ratio > 1.3||0.78||Fail|
|Opportunities||Return on Equity > 15%||12.4%||Fail|
|Valuation||Normalized P/E < 20||21.91||Fail|
|Dividends||Current Yield > 2%||3%||Pass|
|5-Year Dividend Growth > 10%||7.3%||Fail|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Aqua America last year, the water company has kept its three-point score. Yet water is playing an ever more important role in economic growth.
Utilities have traditionally been an unexciting place for investors. Despite high dividend yields, utility stocks generally didn't produce much growth for shareholders.
But water in particular has become a growth industry. Veolia Environnement (NYSE: VE ) is the largest water services company in the world, and it's poised to grow strongly as demand for clean water rises along with emerging-market populations. Nalco (NYSE: NLC ) , meanwhile, benefits from the chemical processes needed for water treatment and pollution control, as well as other industrial processes including oil production.
Of course, as a domestic-focused utility, Aqua America doesn't have quite the reach of Veolia or Nalco. But even as U.S. investors pay more attention to California Water Service (NYSE: CWT ) and American States Water (NYSE: AWR ) , both of which focus on the parched West, Aqua America has rolled out sustainability initiatives that try to capture business from smaller municipal systems in the eastern half of the country.
With substantial debt, modest returns on equity, and a valuation that's by no means cheap, Aqua America isn't the perfect stock. But with some effort, the water company could get closer to perfection in the years to come -- especially if trends toward increased water demand continue.
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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