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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 Lockheed Martin (NYSE: LMT ) 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 Lockheed.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||4.7%||fail|
|1-Year Revenue Growth > 12%||8.1%||fail|
|Margins||Gross Margin > 35%||10.5%||fail|
|Net Margin > 15%||6%||fail|
|Balance Sheet||Debt to Equity < 50%||128.1%||fail|
|Current Ratio > 1.3||1.20||fail|
|Opportunities||Return on Equity > 15%||75.9%||pass|
|Valuation||Normalized P/E < 20||10.14||pass|
|Dividends||Current Yield > 2%||4.3%||pass|
|5-Year Dividend Growth > 10%||20.3%||pass|
|Total Score||4 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of 4, Lockheed doesn't qualify as the perfect stock. Despite its vulnerabilities, though, the company does have some good prospects going forward.
Lockheed is well-known for producing military fighter jets for the U.S. government, but its business goes a lot further than that. Lockheed also makes electronic systems, develops information technology systems, and produces satellites and other space-based applications for both military purposes and space exploration.
In the past, Lockheed has done a good job of partnering with other companies in the defense space to win lucrative contracts. With its F-35 Lightning II fighter jet, for instance, Lockheed worked with subcontractors including General Electric (NYSE: GE ) and Northrop Grumman (NYSE: NOC ) to beat out competitor Boeing (NYSE: BA ) and win the Pentagon bid -- a job that could bring in $1 trillion in revenue. It has also recently brought in contracts to work on computer systems for the Social Security Administration and surveillance systems for New York City's subways.
The big challenge for Lockheed, though, is maintaining its strength in a hostile environment for defense spending. Raytheon (NYSE: RTN ) and Boeing have already suffered major losses from budget cuts, and despite Lockheed's diverse business segments, it remains dependent on government spending to a large extent. Its low margins and fairly high debt load show the capital intensity of its business, and an unexpected downturn could hit the company hard.
The nice thing is that those fears are reflected in the stock's attractive valuation. And with a strong dividend yield, Lockheed rewards shareholders willing to take those risks. Lockheed isn't the perfect stock, but if you think predictions of fiscal austerity are overblown or that a relatively peaceful globe may turn hot in the coming years, Lockheed could make a good stock for your portfolio.
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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