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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 Valero Energy (NYSE: VLO ) 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 Valero.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||2.9%||fail|
|1-Year Revenue Growth > 12%||33.8%||pass|
|Margins||Gross Margin > 35%||4.8%||fail|
|Net Margin > 15%||(0.8%)||fail|
|Balance Sheet||Debt to Equity < 50%||52.2%||fail|
|Current Ratio > 1.3||1.45||pass|
|Opportunities||Return on Equity > 15%||3.4%||fail|
|Valuation||Normalized P/E < 20||20.76||fail|
|Dividends||Current Yield > 2%||1%||fail|
|5-Year Dividend Growth > 10%||10.8%||pass|
|Total Score||3 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Valero's score of 3 doesn't make it look anything close to perfect. Unlike other players in the energy space, Valero has found itself in a difficult position lately, and higher energy prices aren't necessarily the answer to the company's problems.
The key to understanding the disconnect between refiners like Valero and big oil companies is that they have vastly different business models. Oil producers benefit when the price of crude rises. But for refiners, crude oil is the raw material they need to make gasoline, heating oil, and other refined energy products. So it's the so-called crack spread -- the difference between what refiners pay for crude versus what they earn from selling the resulting refined products -- that governs profitability.
Along with fellow independent refiners Frontier Oil (NYSE: FTO ) , Tesoro (NYSE: TSO ) , and Holly (NYSE: HOC ) , Valero went through tough times in recent years. Even during the energy boom days of early 2008, when oil spiked near $150 per barrel, Valero was starting to show the strain from falling crack spreads. Then, when the economy turned sour, so did Valero's bottom line. The environment didn't get much better in 2009, when energy prices plummeted and the company's revenue dropped 40%.
Now, though, it looks like Valero may have hit bottom. The company has posted big gains during the past two quarters, and refining margins that started looking more attractive earlier this year are now starting to pay off.
Refining is a cyclical business, and near the low end of the cycle, none of the refiners looks good in hindsight. But looking forward, things may be getting better for Valero and its peers.
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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