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 WellPoint (NYSE: WLP ) 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 WellPoint.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||8.2%||fail|
|1-Year Revenue Growth > 12%||(2.7%)||fail|
|Margins||Gross Margin > 35%||24.2%||fail|
|Net Margin > 15%||8.6%||fail|
|Balance Sheet||Debt to Equity < 50%||40.7%||pass|
|Current Ratio > 1.3||1.90||pass|
|Opportunities||Return on Equity > 15%||21.5%||pass|
|Valuation||Normalized P/E < 20||8.99||pass|
|Dividends||Current Yield > 2%||0.0%||fail|
|5-Year Dividend Growth > 10%||0.0%||fail|
|Total Score||4 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With just four points, WellPoint falls well short of perfect. But despite going through some very tough years, things may be looking up for the health-insurance provider.
The entire health-insurance industry has suffered greatly ever since health-care reform became a serious possibility. Two years ago, even before the overall stock market started melting down, WellPoint saw its shares drop 50% on the prospects of higher medical costs and slowing enrollment growth. Competitor UnitedHealth Group (NYSE: UNH ) saw similar declines around the same time. Subsequently, the health-care law has only boosted worries, as increased regulation could curtail profits.
WellPoint has both strengths and weaknesses in its industry. It has higher returns on equity than UnitedHealth, Cigna (NYSE: CI ) , and Aetna (NYSE: AET ) , but its recent revenue growth is at the bottom of the barrel, and it's the only one of the four stocks not to pay a dividend. Part of WellPoint's revenue drop comes from the company's sale of its pharmacy benefit management business to ExpressScripts (Nasdaq: ESRX ) last year, but it's clear that health insurance isn't proving to be the high-growth business that demographic trends might have suggested it would become.
The big factor that WellPoint has going for it is valuation. At less than 10 times normalized earnings, the stock is priced for an absolute disaster. If the Republican takeover of the House succeeds in curtailing the impact of health-care reform, then it may prove the perfect catalyst for a rebound in the industry.
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.
Click here to add WellPoint to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.