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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 Northrop Grumman (NYSE: NOC ) 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 Northrop Grumman.
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
Northrop manages to earn a middle-of-the-road score of 5. Nervous investors have bid down the defense contractor's shares to attractive levels, and the stock pays a nice dividend. But future growth concerns plague the entire industry.
It's no secret that defense stocks across the board are mostly much cheaper than the overall market. As fellow Fool editor Andrew Tonner observed last month, the PowerShares Aerospace & Defense ETF (NYSE: PPA ) trades at a much lower multiple than the S&P 500, as fears of budget cuts have weighed on the sector. Yet a closer look at the Department of Defense's own budget requests indicate that real spending is more likely to grow over time or remain relatively flat, even as the nation tries to disengage from conflicts in Iraq and Afghanistan.
So if the defense industry in general is interesting, is Northrop the best stock? If you're focused on dividend yield, then Lockheed Martin (NYSE: LMT ) and Raytheon (NYSE: RTN ) beat out Northrop. On valuation, L-3 Communications (NYSE: LLL ) trades at a normalized multiple of under 10. And if you want better margins and a slightly cleaner balance sheet, General Dynamics (NYSE: GD ) gives you a lower debt-to-equity ratio and faster dividend growth to boot.
With the sector as beaten down as it has been, though, Northrop's hopes for success are largely the same ones as its competitors: making sure government spending decreases doesn't torpedo their future. Northrop hasn't distinguished itself as perfect right now, but its shares are a good value to compensate for the risk you're taking on.
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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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our 13 Steps to Investing Foolishly.