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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 Alcoa (NYSE: AA ) 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 Alcoa.
What We Want to See
Pass or Fail?
|Growth||5-year annual revenue growth > 15%||(3.6%)||fail|
|1-year revenue growth > 12%||11.2%||fail|
|Margins||Gross margin > 35%||15.7%||fail|
|Net margin > 15%||(1.4%)||fail|
|Balance Sheet||Debt to equity < 50%||69.7%||fail|
|Current ratio > 1.3||1.39||pass|
|Opportunities||Return on equity > 15%||(2%)||fail|
|Valuation||Normalized P/E < 20||NM||fail|
|Dividends||Current yield > 2%||0.9%||fail|
|5-year dividend growth > 10%||(27.5%)||fail|
|Total Score||1 out of 10|
Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful because of negative earnings during period. Total score = number of passes.
Scoring just a single point, Alcoa definitely falls short of perfect. Despite some recent positive signs, the aluminum maker still faces an uphill struggle.
Earlier this month, Alcoa surprised analysts with revenue and profit gains. Unfortunately, those expectations were pretty low, and there hasn't been much to get excited about in the industry lately. Smaller competitors Century Aluminum (Nasdaq: CENX ) and Kaiser Aluminum (Nasdaq: KALU ) have actually experienced revenue declines in the past year, and all three have had shrinking sales since 2005.
That's especially disconcerting given the interest in commodities in recent years, but unlike natural resources companies, aluminum makers suffer when the cost of their raw materials goes up. Even Aluminum Corp. of China (NYSE: ACH ) , which you might think was in a dominant position given China's fast growth, has experienced net losses this year.
Alcoa's in a tough industry at a tough time, and investors can't be confident that things will get better soon. Until the company proves it can face its challenges, those seeking the perfect stock should look elsewhere.
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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