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 American Equity Investment Life (NYSE: AEL ) 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 American Equity Investment Life.
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of 5, American Equity Investment Life's stock doesn't look perfect. But the company's growth is impressive, especially in light of the financial crisis.
American Equity has carved out an interesting niche in the insurance industry. More than 90% of its business comes from sales of fixed index annuities, which offer investors returns linked to the performance of stock market indexes but with some downside protection. Unfortunately, much of the company's operating income comes from surrender penalties it collects when investors change their mind about owning annuities for the long run. That has raised concern from consumer advocates that could eventually jeopardize American Equity's business.
Looking at some of American Equity's larger rivals shows some the challenges the industry is facing right now. Genworth Financial (NYSE: GNW ) and Hartford Financial (NYSE: HIG ) have actually seen revenue contract over the past five years. Even healthier-growing competitors MetLife (NYSE: MET ) and Prudential Financial (NYSE: PRU ) can't come close to matching American Equity's growth record since early 2006.
In addition, margins have never been particularly attractive in the sector, as state governments regulate insurance products to put a cap on profits. That's one reason why American Equity and most of its fellow insurance companies trade at low valuations right now. American Equity, for instance, trades at just 73% of its tangible book value -- not the cheapest insurance company out there, but still a fairly attractive value.
American Equity has benefited from interest in the protective qualities of index annuities. As long as investors feel more comfortable with those products than with investing in stocks, then American Equity could continue to see further growth.
Keep searching
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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