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 H&R Block (NYSE: HRB ) 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 H&R Block.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||(0.5%)||Fail|
|1-Year Revenue Growth > 12%||(4.7%)||Fail|
|Margins||Gross Margin > 35%||39.6%||Pass|
|Net Margin > 15%||13%||Fail|
|Balance Sheet||Debt to Equity < 50%||131.7%||Fail|
|Current Ratio > 1.3||0.91||Fail|
|Opportunities||Return on Equity > 15%||52.4%||Pass|
|Valuation||Normalized P/E < 20||8.13||Pass|
|Dividends||Current Yield > 2%||4.5%||Pass|
|5-Year Dividend Growth > 10%||5.7%||Fail|
|Total Score||4 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
H&R Block weighs in with 4 points, falling well short of perfect. The tax specialist is entering the strong part of its year, but its financial metrics don't show the strength that investors would want from a perfect stock.
H&R Block is still struggling to recover from some mistakes it has made. Its ill-timed foray into the mortgage lending market turned out badly, and the company still faces profit pressures from the resulting collateral damage of the housing bust. And now, the company won't be able to offer its lucrative refund anticipation loans, due to exclusive partner HSBC (NYSE: HBC ) being barred by federal regulators from making such loan. It even got fined by the Financial Industry Regulatory Authority for insufficiently supervising some of its financial representatives.
Meanwhile, primary competitor Intuit (Nasdaq: INTU ) continues to see strength from its TurboTax software. Intuit has gradually taken market share away from live providers like H&R Block and Jackson Hewitt.
So far, H&R Block has been able to maintain a strong dividend, and at a low valuation, the shares may look attractive to value investors. Its low payout ratio suggests that the company could maintain its dividend for some time even with no profit growth.
To become a perfect stock, though, H&R Block needs to reverse its past mistakes and start moving forward. As customers get more comfortable with tax software, the provider of live services faces an uphill battle on that front.
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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