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 Exelon (NYSE: EXC ) 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 Exelon.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||3.9%||Fail|
|1-Year Revenue Growth > 12%||1.5%||Fail|
|Margins||Gross Margin > 35%||35.2%||Pass|
|Net Margin > 15%||13.2%||Fail|
|Balance Sheet||Debt to Equity < 50%||93.8%||Fail|
|Current Ratio > 1.3||1.10||Fail|
|Opportunities||Return on Equity > 15%||17.9%||Pass|
|Valuation||Normalized P/E < 20||10.09||Pass|
|Dividends||Current Yield > 2%||5.6%||Pass|
|5-Year Dividend Growth > 10%||5.6%||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Exelon last year, the company has lost a point. A drop in the company's current ratio is to blame for the loss, but Exelon's bigger issue is the role that nuclear power will play in the U.S. electrical generation industry going forward.
2011 was generally a favorable year for most electric utilities. Extremely low natural gas prices also pulled coal costs down, leaving Duke Energy (NYSE: DUK ) , Dominion Resources (NYSE: D ) , and Southern Company (NYSE: SO ) all sporting returns of around 30% for the year. But although Exelon had a reasonable return, it lagged most of its peers, with gains of just over 10% in 2011. That's largely because as a distributor of natural gas and electricity, weakness in natural gas works both for and against Exelon.
Another reason may have to do with its recent acquisition of Constellation Energy. The buyout allows Exelon to expand its natural gas service in Maryland, allowing for a bigger rebound when natural gas prices start to rise.
One headwind Exelon may soon face comes from its nuclear power plants. The Nuclear Regulatory Commission proposed new safety rules that could add millions in costs for Exelon, Southern, and other nuclear plant operators. As the largest nuclear-power-generating company in the U.S., Exelon probably stands to lose the most from such a move.
To get back in the winning column, Exelon needs a rebound in natural gas prices to boost revenue. Once that comes, better margins may follow, earning the company at least a few more points in its bid for perfection.
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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