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 Dow Chemical
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 Dow.
|
Factor |
What We Want to See |
Actual |
Pass or Fail? |
|---|---|---|---|
| Growth | 5-Year Annual Revenue Growth > 15% | 2.9% | fail |
| 1-Year Revenue Growth > 12% | 21.1% | pass | |
| Margins | Gross Margin > 35% | 14.6% | fail |
| Net Margin > 15% | 3.8% | fail | |
| Balance Sheet | Debt to Equity < 50% | 96.5% | fail |
| Current Ratio > 1.3 | 1.57 | pass | |
| Opportunities | Return on Equity > 15% | 9.2% | fail |
| Valuation | Normalized P/E < 20 | 32.85 | fail |
| Dividends | Current Yield > 2% | 1.9% | fail |
| 5-Year Dividend Growth > 10% | (14.8%) | fail | |
| Total Score | 2 out of 10 |
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Dow falls well short of perfection with a score of just 2. Even worse, it remains unclear whether the chemical maker's steps to get moving in the right direction will work.
Like rivals DuPont
Unfortunately, a series of setbacks has hampered Dow's progress. Separate problems at its Argentina and Texas plants hurt earnings earlier this year. Discontinued operations have forced the company to take further charges against earnings. Yet, things may be getting better. In the most recent quarter, Dow saw growth return, with its basic chemicals segment seeing 33% higher revenue.
Comparing Dow with its rivals, it comes up short in many respects. DuPont sports much higher returns on equity, while Celanese and Eastman have higher net margins. More importantly, Dow trades at higher earnings multiples than all three. Unless Dow gets its act together, it'll be a while before it comes close to being perfect.
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.
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