Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Ryland (NYSE: RYL ) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- 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 mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. 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 Ryland.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(26.1%)||Fail|
|1-Year Revenue Growth > 12%||(17.1%)||Fail|
|Margins||Gross Margin > 35%||14.4%||Fail|
|Net Margin > 15%||(8%)||Fail|
|Balance Sheet||Debt to Equity < 50%||156.7%||Fail|
|Current Ratio > 1.3||8.10||Pass|
|Opportunities||Return on Equity > 15%||(14.9%)||Fail|
|Valuation||Normalized P/E < 20||NM||Fail|
|Dividends||Current Yield > 2%||0.7%||Fail|
|5-Year Dividend Growth > 10%||(16.7%)||Fail|
|Total Score||1 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With just a single point, Ryland falls well short of perfection. Even though the entire homebuilding industry has suffered through the housing bust, Ryland has particular challenges that it must face in order to stay competitive.
Recent news from the housing front hasn't bred much optimism about prospects for the industry. Home prices and new home construction continue to fall, prompting many to wonder if buying a house is actually a smart idea in the first place.
But other homebuilders found better ways through the downturn than Ryland. NVR (NYSE: NVR ) , for instance, stayed profitable during the bad times with a capital-saving strategy that emphasized land options rather than buying land outright. DR Horton (NYSE: DHI ) and Meritage Homes (NYSE: MTH ) have returned to modest profitability. Even PulteGroup (NYSE: PHM ) , which continues to lose money, has positive cash flow. In addition, Ryland has high debt levels even for the industry.
To recover, Ryland needs a big recovery in housing to wipe out inventory and get its income moving in the right direction. Until that happens, Ryland isn't going to be the perfect stock.
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.