Is InterOil the Perfect Stock?

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 InterOil (NYSE: IOC  ) 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 InterOil.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

22.4%

pass

 

1-Year Revenue Growth > 12%

(0.7%)

fail

Margins

Gross Margin > 35%

12.4%

fail

 

Net Margin > 15%

(0.2%)

fail

Balance Sheet

Debt to Equity < 50%

23.6%

pass

 

Current Ratio > 1.3

1.60

pass

Opportunities

Return on Equity > 15%

(0.3%)

fail

Valuation

Normalized P/E < 20

NM

fail

Dividends

Current Yield > 2%

0.0%

fail

 

5-Year Dividend Growth > 10%

0.0%

fail

       
 

Total Score

 

3 out of 10

Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful; InterOil had negative normalized earnings over the period. Total score = number of passes.

A score of 3 may not make much sense for a company that has seen its shares jump 76% in the past year. But InterOil draws strong opinions, both pro and con, from those who follow it.

On one hand, the Australian-based company, which focuses on refining and energy production, announced a deal to build a liquefied natural gas project in Papua New Guinea. Investors hope that if successful, the project can feed a hungry Chinese appetite for energy resources with LNG from its own backyard. ExxonMobil (NYSE: XOM  ) already has a similar LNG project planned in the island nation.

Some skeptics, on the other hand, have trouble believing that the company is even a legitimate operation. Allegations of fraud have grown so rampant that the SEC recently investigated some who have shorted the stock, including Barry Minkow, who himself was convicted of fraud and now investigates companies, looking for troublesome activity. Whitney Tilson of T2 Partners has also pointed to a number of disturbing factors about the deal.

Regardless of the controversy, the financials clearly show that InterOil hasn't yet delivered on its potential. With low refining margins having hurt the stocks of U.S. refiners Valero (NYSE: VLO  ) and Tesoro (NYSE: TSO  ) , InterOil's advance can only be explained by speculation that the company will hit a home run in the western Pacific. Only time will tell whose argument proves correct.

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.

The Motley Fool is recommending 50 stocks in 50 days for its new "11 O'Clock Stock" series. For more information, click here. Then come back to Fool.com every single weekday at 11 a.m. ET for a brand-new pick!

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Fool owns shares of Exxon Mobil. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


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