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 National Grid (NYSE: NGG ) 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 National Grid.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||9.7%||Fail|
|1-Year Revenue Growth > 12%||(3.6%)||Fail|
|Margins||Gross Margin > 35%||75.6%||Pass|
|Net Margin > 15%||14.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||264.5%||Fail|
|Current Ratio > 1.3||0.88||Fail|
|Opportunities||Return on Equity > 15%||22.3%||Pass|
|Valuation||Normalized P/E < 20||14.85||Pass|
|Dividends||Current Yield > 2%||5.7%||Pass|
|5-Year Dividend Growth > 10%||6.5%||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
Since we looked at National Grid last year, the company has dropped a point. The utility's margins finally fell below the key 15% level, but the stock has managed to give shareholders a reasonable 15% gain over the past year.
National Grid isn't your typical utility play. Although it has coverage in the northeastern U.S., the utility focuses largely on its U.K. gas and electricity transmission networks. That gives the company some diversification but also forces it to deal with two different regulatory frameworks.
One challenge for National Grid's U.S. operations is that its coverage area isn't seeing much population growth, as New England has lost many former residents to warmer climes. By contrast, Duke Energy (NYSE: DUK ) and NextEra Energy (NYSE: NEE ) have customer bases in the fast-growing South that give those utilities more U.S. growth potential.
But National Grid is making the most of its opportunities in the U.K., recently announcing a deal that could bring in as much as five gigawatts of clean energy from Irish producers. Given the impact that clean energy has had on well-established wind-turbine maker General Electric (NYSE: GE ) and budding American Superconductor (Nasdaq: AMSC ) , National Grid is smart to make further inroads into renewables on its home turf.
For National Grid to improve, it needs to reverse the trend toward shrinking revenues and get its margins moving upward. Clean energy might be a way to do that, and once it's done, getting its balance sheet in better order could help National Grid move toward perfection in the years ahead.
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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