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 Cliffs Natural Resources (NYSE: CLF ) 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 Cliffs Natural Resources.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-year annual revenue growth > 15%||18.9%||Pass|
|1-year revenue growth > 12%||14.8%||Pass|
|Margins||Gross margin > 35%||30.1%||Fail|
|Net margin > 15%||15.3%||Pass|
|Balance sheet||Debt to equity < 50%||28.6%||Pass|
|Current ratio > 1.3||2.28||Pass|
|Opportunities||Return on equity > 15%||19.8%||Pass|
|Valuation||Normalized P/E < 20||16.51||Pass|
|Dividends||Current yield > 2%||0.8%||Fail|
|5-year dividend growth > 10%||36.5%||Pass|
|Total Score||8 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
A score of 8 for Cliffs is exceptionally good, reflecting a great deal of strength in an industry you might expect would've been hurt more by the recession. Cliffs produces iron ore and metallurgical-grade coal, both of which are key ingredients for steel production.
Steel has been a key beneficiary of China's explosive growth story, with top players BHP Billiton (NYSE: BHP ) and Rio Tinto (NYSE: RTP ) fighting it out to supply Chinese steelmakers with the raw materials they need. But even though the core of Cliffs' business is in North America, it still has supply agreements both domestically and within the Asia-Pacific region. A strategy of acquisitions has improved its geographical diversity and helped it produce its strong growth.
With a stronger balance sheet and much more impressive growth than fellow producers Peabody Energy (NYSE: BTU ) and CONSOL Energy (NYSE: CNX ) , Cliffs stands near the top of its industry. If the global economy can continue to recover from the recession, Cliffs has excellent prospects 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.