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 Goldman Sachs (NYSE: GS ) 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 Goldman.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||11.4%||fail|
|1-Year Revenue Growth > 12%||(13.6%)||fail|
|Margins||Gross Margin > 35%||94.7%||pass|
|Net Margin > 15%||25.2%||pass|
|Balance Sheet||Debt to Equity < 50%||536.8%||fail|
|Current Ratio > 1.3||1.53||pass|
|Opportunities||Return on Equity > 15%||14.95%||fail|
|Valuation||Normalized P/E < 20||7.17||pass|
|Dividends||Current Yield > 2%||0.8%||fail|
|5-Year Dividend Growth > 10%||7.0%||fail|
|Total Score||4 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Figures adjusted to reflect change in Goldman's fiscal year. Total score = number of passes.
Goldman weighs in with a mediocre 4. However, given the turmoil in the financial industry over the past several years, that score isn't as bad as it looks.
We all know too well about the financial crisis that struck Goldman and its peers in the fall of 2008. That crisis forced the company to get expensive financing from Warren Buffett's Berkshire Hathaway (NYSE: BRK-B ) , providing for a 10% dividend on preferred shares and warrants that give Berkshire the option to buy additional shares in the future.
The company's image hasn't improved much in the interim. Goldman had to pay $550 million to settle the SEC's investigation of fraud related to its sale of mortgage-backed securities.
But the company's financial results have recovered sharply from 2008's levels and compare favorably with its competitors. The shares are valued more cheaply than Morgan Stanley's (NYSE: MS ) despite having higher returns on equity and lower debt levels. Moreover, with Wells Fargo (NYSE: WFC ) , JPMorgan Chase (NYSE: JPM ) , and Goldman all among banks expected to pass the next round of stress tests, Goldman could be in line to increase its dividend to more respectable levels.
Goldman may never return to its former glory. But even if you're tempted to bet against the future of Wall Street, I wouldn't recommend picking Goldman as your first target.
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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