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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 American Express (NYSE: AXP ) 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 American Express.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||3.8%||fail|
|1-Year Revenue Growth > 12%||30.7%||pass|
|Margins||Gross Margin > 35%||77.7%||pass|
|Net Margin > 15%||15.3%||pass|
|Balance Sheet||Debt to Equity < 50%||448%||fail|
|Current Ratio > 1.3||2.50||pass|
|Opportunities||Return on Equity > 15%||24.8%||pass|
|Valuation||Normalized P/E < 20||17.75||pass|
|Dividends||Current Yield > 2%||1.7%||fail|
|5-Year Dividend Growth > 10%||8.4%||fail|
|Total Score||6 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
American Express weighs in with a fairly strong score of 6. Even though the card issuer faces some challenges in a changing environment, the recovery has helped reverse some troubling trends.
Unlike card network companies Visa (NYSE: V ) and MasterCard (NYSE: MA ) , American Express both issues its brand-name cards and retains the credit risk on some of them. But because its customers tend to be wealthier than the average credit card holder, that credit risk isn't as big a problem as it is with competitors. For instance, in October, AmEx saw delinquency rates fall to 2.3% and wrote off loans at an annual rate of 4.7% -- figures well below what Bank of America (NYSE: BAC ) and Capital One (NYSE: COF ) reported.
One of the biggest successes at American Express has been getting customers to pay annual fees for its cards. Fees have consistently brought in around $2 billion annually for the company. Moreover, travel services and travelers checks also help the company go beyond credit cards.
The biggest threat to AmEx right now is an antitrust lawsuit for its practices in dealing with the merchants that accept its cards. Visa and MasterCard avoided suits by settling with the Department of Justice, so AmEx will be on its own defending its merchant arrangements. But assuming that the company can get past the litigation without losing too much of its profitability, the strong American Express brand should continue to help it prosper even amid ongoing credit card reform.
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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