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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 whether Holly Corp. (NYSE: HOC ) 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 Holly.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-year annual revenue growth > 15%||22.2%||Pass|
|1-year revenue growth > 12%||90.1%||Pass|
|Margins||Gross margin > 35%||4.5%||Fail|
|Net margin > 15%||0.6%||Fail|
|Balance sheet||Debt to equity < 50%||64.8%||Fail|
|Current ratio > 1.3||1.16||Fail|
|Opportunities||Return on equity > 15%||6.3%||Fail|
|Valuation||Normalized P/E < 20||46.98||Fail|
|Dividends||Current yield > 2%||1.1%||Fail|
|5-year dividend growth > 10%||27.2%||Pass|
|Total Score||3 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
Holly doesn't light up the charts with its score of three. But improvement in its core business plus a big strategic move could change things quickly.
Holly is in the oil refining business, with refineries in Oklahoma, New Mexico, and Utah. Refining has gone through some tough times in the past few years, as the collapse in energy prices during the 2008 market meltdown punished share prices across the industry.
Recently, though, fundamentals for refining have become more favorable. Although some fear that those improvements are illusory, they've nonetheless pushed up shares of companies throughout the industry, including Valero Energy (NYSE: VLO ) and Western Refining (NYSE: WNR ) , with Holly more than doubling in the past year.
Just yesterday, Holly announced it is planning to merge with Frontier Oil (NYSE: FTO ) , a fellow refiner, in a combination that would create a $7 billion company. If the joint company can produce the hoped-for benefits of increased scale and savings of $30 million annually from cost synergies, the move could be exactly what shareholders need to catalyze future growth.
With most of the tests in the table above looking backward, Holly's numbers reflect its difficult past. The future looks brighter, though. Those interested in energy stocks should keep an eye on Holly and its refining competitors.
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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