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 whether United Parcel Service (NYSE: UPS ) 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 UPS.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||4.1%||fail|
|1-Year Revenue Growth > 12%||(0.2%)||fail|
|Margins||Gross Margin > 35%||22.5%||fail|
|Net Margin > 15%||5.7%||fail|
|Balance Sheet||Debt to Equity < 50%||130.5%||fail|
|Current Ratio > 1.3||1.43||pass|
|Opportunities||Return on Equity > 15%||36.6%||pass|
|Valuation||Normalized P/E < 20||25.22||fail|
|Dividends||Current Yield > 2%||2.7%||pass|
|5-Year Dividend Growth > 10%||8.6%||fail|
|Total Score||3 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
The recession hasn't been kind to UPS, which comes in with a score of 3. The shipping and delivery company is a bellwether for economic conditions, and when overall business activity is slow, UPS doesn't get the volume it needs to reap the biggest profits from its sophisticated and capital-intensive operational structure.
UPS has followed a slightly different course from rival FedEx (NYSE: FDX ) . UPS's higher debt levels boost its returns on equity, but they also bring more risk from leverage if things go badly.
What some don't realize about UPS, however, is that it doesn't just deliver packages. It also has a freight services business that competes with truckload and less-than-truckload carriers like YRC Worldwide (Nasdaq: YRCWD ) and Landstar System (Nasdaq: LSTR ) . UPS's freight and supply chain segment represented 16% of its overall revenue in 2009, but it's a low-margin business that pulls down UPS's overall profit margins.
It's easy to conclude that once a global recovery takes hold, UPS should benefit. But the stock's valuation already seems to be pricing that recovery in. With shares already fairly rich, UPS may not rise as much as other beaten-down transportation companies. But for conservative investors who don't want a whole lot of volatility, UPS offers stability and a good dividend.
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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