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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 Raytheon (NYSE: RTN ) 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 areas, which 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 Raytheon.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||6.4%||Fail|
|1-Year Revenue Growth > 12%||1.2%||Fail|
|Margins||Gross Margin > 35%||19.4%||Fail|
|Net Margin > 15%||7.3%||Fail|
|Balance Sheet||Debt to Equity < 50%||37%||Pass|
|Current Ratio > 1.3||1.48||Pass|
|Opportunities||Return on Equity > 15%||18.4%||Pass|
|Valuation||Normalized P/E < 20||12.38||Pass|
|Dividends||Current Yield > 2%||3%||Pass|
|5-Year Dividend Growth > 10%||11.3%||Pass|
|Total Score||6 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Raytheon clocks in with six points. With the turmoil that the defense industry has gone through lately, though, it's not surprising to see the contractor fall short of perfection.
Everyone knows that the U.S. government has been running large deficits. Just yesterday, Fed Chairman Ben Bernanke called on Congress to impose fiscal restraint in light of the ballooning national debt.
Threats of a shrinking federal budget have investors in defense contractors concerned. Throughout the sector, defense stocks trade at very low valuations. Lockheed Martin (NYSE: LMT ) , General Dynamics (NYSE: GD ) , and Northrop Grumman (NYSE: NOC ) have normalized P/Es very close to Raytheon's, and their forward earnings multiples are similarly close to one another.
With so much uncertainty, you can understand why these stocks are out of favor. But recent tensions in Egypt have shown that the world remains a dangerous place, and despite budgetary woes, the U.S. is unlikely to give up its role as a military superpower without a fight. In fact, their prospects are so intertwined that fellow Fool Anand Chokkavelu recommended buying them all.
With cuts likely, growth constraints may keep Raytheon and its peers from becoming perfect stocks. But for a strong company with a healthy and growing dividend, Raytheon would make a good investment for many investors.
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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