Is Valero the Perfect Stock?

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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.

Keep searching
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.

Click here to add Valero to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.

Read/Post Comments (1) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 08, 2010, at 3:31 PM, king4life wrote:

    LPH is the perfect stock in the energy biz.

    It distributes from the refiner as a wholesaler.

    It doesn't care about the price of oil and the retail price is fixed by the Government.

    If oil does go up, the Government raises the retail maximum so LPH makes even more. It only has to worry about it's own inventory and make sure it doesn't get caught if the price of oil goes down.

    Even then it has like 22 days to get rid of it.

    Oh BTW, they are in China.

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