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 whether United Continental (NYSE: UAL ) 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 United Continental.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||11.3%||Fail|
|1-Year Revenue Growth > 12%||76.6%||Pass|
|Margins||Gross Margin > 35%||28.2%||Fail|
|Net Margin > 15%||1.2%||Fail|
|Balance Sheet||Debt to Equity < 50%||762.8%||Fail|
|Current Ratio > 1.3||0.95||Fail|
|Opportunities||Return on Equity > 15%||NM||NM|
|Valuation||Normalized P/E < 20||9.27||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||2 out of 9|
Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful due to negative average shareholder equity over the past year. Total score = number of passes.
With just two points, United Continental isn't flying high. The airline resulting from the merger of United and Continental has tried to build a competitive advantage, but tough times are holding the whole industry down.
Over the years, airlines have struggled to make a profit. To some degree, they've successfully compensated for high fuel costs by turning to fee revenue. According to U.S. Department of Transportation data, fees for baggage and reservation changes added up to $5.7 billion in 2010. Delta Air Lines (NYSE: DAL ) led the way with nearly $1 billion from baggage fees alone, but United Continental and AMR's (NYSE: AMR ) American Airlines also reaped big benefits.
Now, though, the positive impact from fees seems to be petering out. Late last month, United Continental gave shareholders more bad news. The stock fell sharply after the company said that revenue for the second quarter would be disappointing and that it would have to take a $110 million charge related to its frequent flier program. With June revenue per seat mile rising at a very slow pace due in part to weather, it seems that the combined airline hasn't given investors what they'd hoped to see.
Yet airlines are responding by redoubling their efforts to increase capital spending. AMR aims to spend an estimated $15 billion to buy aircraft from Boeing (NYSE: BA ) and Airbus, and Delta plans to add 200 new aircraft by the end of 2011. Southwest (NYSE: LUV ) and United Continental may follow suit with purchases of their own.
In a still-fragile economy, the airline industry still has huge headwinds beating it back. United Continental may be better off together than apart, but it's still not a perfect stock by a long shot.
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."