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 NorthStar Realty Finance (NYSE: NRF ) 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 NorthStar.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||28.9%||pass|
|1-Year Revenue Growth > 12%||2%||fail|
|Margins||Gross Margin > 35%||60.6%||pass|
|Net Margin > 15%||NM||fail|
|Balance Sheet||Debt to Equity < 50%||229.6%||fail|
|Current Ratio > 1.3||11.22||pass|
|Opportunities||Return on Equity > 15%||(20.5%)||fail|
|Valuation||Normalized P/E < 20||NM||fail|
|Dividends||Current Yield > 2%||9.1%||pass|
|5-Year Dividend Growth > 10%||(12.9%)||fail|
|Total Score||4 out of 10|
Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful; NorthStar Realty had negative net profits over the periods measured. Total score = number of passes.
With a score of 4, NorthStar isn't lighting up the night sky with its performance. Despite a strong dividend, the company is in an extremely risky business with plenty of downside potential.
NorthStar is organized as a real-estate investment trust and is involved in commercial real-estate debt and net-lease investments. That's markedly different from what mortgage REITs Annaly Capital (NYSE: NLY ) and American Capital Agency (Nasdaq: AGNC ) are doing, as instead of simply trying to play interest rate spreads in the mortgage market, NorthStar actually has at least some exposure to the health of the businesses that enter into its leases. Those commitments range from big customers like Lockheed Martin (NYSE: LMT ) to small convenience stores and fast-food restaurants, which have held up surprisingly well during the recession.
As an investment, NorthStar has given shareholders a rocky ride. Earnings have posted big surprises on both the positive and negative sides in recent quarters. Shares have bounced nicely but are still well below where they traded at their 2007 peak. And with the future still uncertain, investors can expect that volatility to continue.
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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