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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 PulteGroup (NYSE: PHM ) 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 Pulte.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(17.7%)||fail|
|1-Year Revenue Growth > 12%||28%||pass|
|Margins||Gross Margin > 35%||11.7%||fail|
|Net Margin > 15%||(20.5%)||fail|
|Balance Sheet||Debt to Equity < 50%||189.9%||fail|
|Current Ratio > 1.3||3.59||pass|
|Opportunities||Return on Equity > 15%||(37.4%)||fail|
|Valuation||Normalized P/E < 20||NM||fail|
|Dividends||Current Yield > 2%||0%||fail|
|5-Year Dividend Growth > 10%||0%||fail|
|Total Score||2 out of 10|
Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful; Pulte had negative earnings during the period. Total score = number of passes.
Pulte only builds a score of 2, revealing its big imperfections. But given the struggles in the housing market, that shouldn't be terribly surprising.
Times are tough throughout the homebuilding industry. Despite some signs of life in the overall economy, huge existing-home inventories and foreclosure backlogs have kept homebuilders from reaping any substantial benefits. Pulte hasn't turned an annual profit since 2006, and even competitors Lennar (NYSE: LEN ) and DR Horton (NYSE: DHI ) , which have finally gotten back in the black, are seeing only modest profits. The big exception is NVR (NYSE: NVR ) , which stayed profitable throughout the downturn thanks to a unique option-based business model.
But things may finally be turning. Toll Brothers (NYSE: TOL ) came out with an optimistic forecast for housing in 2011 and 2012. Still, we've had plenty of early turnaround calls from housing experts over the past several years, yet the housing market isn't out of the woods yet.
Homebuilders may be the next great turnaround story. But for now, Pulte and its peers are far from perfect, and risk-averse investors would be wise to look elsewhere.
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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