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 Honda Motor (NYSE: HMC ) 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 Honda Motor.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(4.1%)||Fail|
|1-Year Revenue Growth > 12%||(7.3%)||Fail|
|Margins||Gross Margin > 35%||26.6%||Fail|
|Net Margin > 15%||3.5%||Fail|
|Balance Sheet||Debt to Equity < 50%||88.7%||Fail|
|Current Ratio > 1.3||1.27||Fail|
|Opportunities||Return on Equity > 15%||7%||Fail|
|Valuation||Normalized P/E < 20||13.10||Pass|
|Dividends||Current Yield > 2%||2.5%||Pass|
|5-Year Dividend Growth > 10%||(3.4%)||Fail|
|Total Score||2 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With only two points, Honda isn't zooming toward the finish line. Between natural disasters and economic woes, the car company has faced big obstacles in its road toward growth.
Honda has stood in the shadows of its larger rival Toyota (NYSE: TM ) for years. With dependable results and reliable products, Honda hasn't seen as much growth as Toyota over the long haul, but it has also avoided the near-death experiences of Ford (NYSE: F ) , General Motors (NYSE: GM ) , and Chrysler.
Then the Japanese earthquake and tsunami hit earlier this year, throwing a wrench into Honda's results. Although Toyota has bounced back fairly quickly from the disasters, Honda still lags behind. But Honda still believes that because suppliers are getting back on line faster than expected, future profits should come in better than previously thought.
One possible avenue for growth may be in emerging markets. Right now, low-margin sellers like Tata Motors (NYSE: TTM ) pose a barrier to entry for the low end of the emerging-market car industry. But as the ranks of the middle class grow in China, India, and elsewhere, Honda could position itself to sell higher-end models to more prosperous buyers.
Honda has a lot of work to do before it could become a perfect stock. But with a history of excellence, a turnaround definitely isn't impossible.
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.