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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 Goodyear Tire (NYSE: GT ) 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 Goodyear.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(1.8%)||fail|
|1-Year Revenue Growth > 12%||5%||fail|
|Margins||Gross Margin > 35%||19.3%||fail|
|Net Margin > 15%||0.9%||fail|
|Balance Sheet||Debt to Equity < 50%||711.6%||fail|
|Current Ratio > 1.3||1.74||pass|
|Opportunities||Return on Equity > 15%||26.4%||pass|
|Valuation||Normalized P/E < 20||10.44||pass|
|Dividends||Current Yield > 2%||0%||fail|
|5-Year Dividend Growth > 10%||0%||fail|
|Total Score||3 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of just 3, Goodyear clearly isn't perfect. Although shares are relatively inexpensive at the moment, the company will likely have a lot of trouble digging itself out of the hole it's in right now.
As you'd expect from a tire company, Goodyear's fortunes are largely tied to the auto industry. But unlike auto parts retailers AutoZone (NYSE: AZO ) and Pep Boys (NYSE: PBY ) , which rely almost solely on owners retooling their current vehicles, about a quarter of Goodyear's revenue comes from tires put on new cars. As a supplier for original tires for Ford Motor (NYSE: F ) , Toyota (NYSE: TM ) , and several GM models among automakers, Goodyear benefits when car and truck sales rise, as they have lately.
But when the financial crisis hit two years ago, Goodyear wasn't ready. It let inventory levels skyrocket, only gradually working it off over the ensuing years. With around $4.4 billion in debt on its balance sheet, the tire company's finances are somewhat strained, although its current ratio shows that it's not in any imminent danger.
Over the long haul, shareholders will want to see the company move toward repaying its debt in the hopes of establishing a dividend. But Goodyear has a long road ahead of it, and even with brand new tires, the company may never reach its destination.
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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