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 Central Fund of Canada (AMEX: CEF ) 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 Central Fund of Canada.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||56%||Pass|
|1-Year Revenue Growth > 12%||278.8%||Pass|
|Margins||Gross Margin > 35%||100%||Pass|
|Net Margin > 15%||99.6%||Pass|
|Balance Sheet||Debt to Equity < 50%||0%||Pass|
|Current Ratio > 1.3||25.43||Pass|
|Opportunities||Return on Equity > 15%||59.8%||Pass|
|Valuation||Normalized P/E < 20||3.13||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||8 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
At first glance, Central Fund of Canada seems to be a dream come true for investors, only lacking a dividend to achieve perfection. But digging deeper, it's apparent that these numbers don't mean what they seem to.
Central Fund of Canada is a closed-end fund that primarily owns gold and silver bullion. Just as bullion ETFs like SPDR Gold (NYSE: GLD ) and iShares Silver Trust (NYSE: SLV ) gained huge popularity during the big run-up in gold and silver prices in recent years, Central Fund has also gained attention from those wanting to invest in precious metals.
The problem with some bullion ETFs, though, is that gains end up getting taxed as collectibles, with a potentially higher tax rate of 28%. That pushes some investors toward miners like Newmont Mining (NYSE: NEM ) and other metals-related stocks like Silver Wheaton (NYSE: SLW ) . But because of an esoteric set of tax rules, investors in Central Fund get better tax treatment on long-term gains than those who use the SPDR or iShares ETFs.
The problem in reading too much into these financials, however, is that they rely on the fact that as a closed-end fund, Central Fund recognizes all of its gains and losses from changes in bullion values as "revenue." So margins aren't really meaningful as measures of investing success, and figures related to sales or net income fluctuate wildly with the performance of the metals. In the past, the company has even reported negative revenue during down years for bullion prices.
None of that means that Central Fund is a bad investment. But you shouldn't read anything into its stated P/E of 3 or its huge returns on equity. The only way Central Fund will keep this high score over the long run is if gold and silver prices continue to rise dramatically as they have in recent years.
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.