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 PPL Corp. (NYSE: PPL ) 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 PPL.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||6.6%||Fail|
|1-Year Revenue Growth > 12%||2.8%||Fail|
|Margins||Gross Margin > 35%||27.5%||Fail|
|Net Margin > 15%||8.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||108.4%||Fail|
|Current Ratio > 1.3||2.12||Pass|
|Opportunities||Return on Equity > 15%||11.2%||Fail|
|Valuation||Normalized P/E < 20||16.02||Pass|
|Dividends||Current Yield > 2%||5.4%||Pass|
|5-Year Dividend Growth > 10%||8.8%||Fail|
|Total Score||3 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of just 3 points, PPL isn't perfect. Even after a good 2010 for the stock market overall, utility stocks have suffered from poor returns lately, and PPL is no exception.
PPL does business generating and delivering electricity in the northeastern and western U.S. as well as the United Kingdom. That puts it in markets similar to those of National Grid (NYSE: NGG ) , but PPL hasn't been able to make as much use of its debt to generate strong returns on equity, and despite attractive payouts, its dividend yield doesn't come close to National Grid's.
PPL doesn't particularly stand out on the growth front or on its margins. Yet PPL trades at a substantial premium to Exelon (NYSE: EXC ) and trades close to the valuation of Southern Company (NYSE: SO ) . That's a bit surprising, given that, again, PPL comes up short on its return on equity compared to its peers.
With utility growth largely subject to regulation and high debt levels being commonplace, neither PPL nor any other utility is likely to become the perfect stock by these measures. But utilities can be a useful way to earn dividends from your portfolio -- as long as you pick the best ones you can find at the most attractive prices.
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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