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 and then decide whether Arch Coal (NYSE: ACI ) 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. Although 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 a 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.
- Moneymaking 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 Arch Coal.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||5.1%||Fail|
|1-Year Revenue Growth > 12%||28.5%||Pass|
|Margins||Gross Margin > 35%||26.0%||Fail|
|Net Margin > 15%||6.6%||Fail|
|Balance Sheet||Debt to Equity < 50%||69.9%||Fail|
|Current Ratio > 1.3||1.64||Pass|
|Opportunities||Return on Equity > 15%||9.8%||Fail|
|Valuation||Normalized P/E < 20||58.98||Fail|
|Dividends||Current Yield > 2%||1.4%||Fail|
|5-Year Dividend Growth > 10%||20.1%||Pass|
|Total Score||3 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Arch Coal can only dig up a score of 3. The coal company has made some big gains lately, though, and has now entered the busy M&A activity in the sector with a deal of its own.
In recent years, coal production has taken on new importance, with the rapid buildup of infrastructure in emerging-market countries such as China. With its vast resources of metallurgical coal, Arch Coal has benefited from strong worldwide demand.
Yet as with any other popular sector, competitors have sought to gain strategic advantages over each other. In January, Alpha Natural Resources (NYSE: ANR ) bought out accident-plagued Massey Energy (NYSE: MEE ) in a $7.1 billion deal, vaulting it in one fell swoop to global scope in the company of Peabody Energy (NYSE: BTU ) and Teck Resources (NYSE: TCK ) . That left Arch Coal potentially on the outside looking in.
Earlier this week, Arch Coal decided to remedy that situation by buying International Coal Group (NYSE: ICO ) in a $3.4 billion deal of its own. The buyout not only returns Arch to No. 2 status among U.S. metallurgical coal companies but also diversifies its holdings geographically, with revenue divided across the nation.
What's left is for Arch Coal to consolidate its new acquisition and try to accelerate its growth. If it can grow faster and improve its balance sheet, Arch Coal could look a lot more like a perfect stock in the near future.
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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