Is Central Fund of Canada the Perfect Stock?

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.

Factor

What We Want to See

Actual

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.

Keep searching
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.

Click here to add Central Fund of Canada to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

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.

Fool contributor Dan Caplinger owns shares of iShares Silver Trust. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 22, 2011, at 11:46 AM, badtyper00 wrote:

    This is one of The Fool's most ridiculous articles ever. I like CEF and am invested in it. But to try and use the analysis methods in this article for a gold and silver bullion fund is ridiculous. It is like trying to use the same methods of analysis for a U.S. treasury bonds. The method of analysis is simply not appropriate. CEF is not a company that has sales and revenue and margins, the same way a U.S. bond doesn't have those items. CEF's price is almost totally dependent upon the price of gold and silver, which the article points out. But, none of the rest of the musings of the writer have anything to do with trying to analyze CEF. They are simply a waste of time for the reader.

  • Report this Comment On June 22, 2011, at 4:20 PM, mrkhan1024 wrote:

    badtyper00 beat me to it. This analysis is completely worthless for this fund.

  • Report this Comment On June 27, 2011, at 8:06 PM, rvertes617 wrote:

    I agree that this article is not useful because the fund is a proxy for bullion investing that is backed by the real physical and it is not a company. The analysis while interesting is like trying to compare a gold bar to a share of a company, not even apples to oranges more like apples to pizza/ I wrote a blog piece that discusses CEF and other bullion related instruments and you can check it out at my blog using the following link ... http://www.monetaadvisors.com/2010/10/gold-doesn-have-to-wei...

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