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 Cliffs Natural Resources (NYSE: CLF ) 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 Cliffs Natural Resources.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||26.5%||Pass|
|1-Year Revenue Growth > 12%||69.4%||Pass|
|Margins||Gross Margin > 35%||40.1%||Pass|
|Net Margin > 15%||26.3%||Pass|
|Balance Sheet||Debt to Equity < 50%||64.9%||Fail|
|Current Ratio > 1.3||1.42||Pass|
|Opportunities||Return on Equity > 15%||32.2%||Pass|
|Valuation||Normalized P/E < 20||5.88||Pass|
|Dividends||Current Yield > 2%||2.1%||Pass|
|5-Year Dividend Growth > 10%||21.4%||Pass|
|Total Score||9 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
When we looked at Cliffs Natural Resources last year, it only managed eight points. The combination of a doubled dividend and a falling stock price has earned the company an extra point, but it still isn't smooth sailing for the materials company.
For a long time, Asian growth has been the key to steel production, and Cliffs has taken big steps to benefit from the macroeconomic trend. Early this year, it bid to acquire Canadian iron ore producer Consolidated Thompson, which will eventually boost its size enough to challenge industry leaders Vale (NYSE: VALE ) , BHP Billiton (NYSE: BHP ) , and Rio Tinto (NYSE: RIO ) .
Yet despite its near-perfect score, Cliffs doesn't have everything going perfectly. The company has faced challenges from high costs for its coal-mining operations. Granted, falling prices for metallurgical coal have hit competitors Patriot Coal (NYSE: PCX ) and Alpha Natural Resources (NYSE: ANR ) hard as well, but the operational missteps that Cliffs has made earn it additional concern. Fortunately, the company has moved away from coal and toward iron ore, where it's a better relative performer.
To get to a perfect 10, all Cliffs needs to do is to cut its somewhat high debt-to-equity ratio. The bigger threat is a slowdown in Asia, but at least for now, Cliffs looks like it's on track to stay near perfection.
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."