Is Dynegy 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 Dynegy (NYSE: DYN) 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 Dynegy.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

(2.3%)

Fail

 

1-Year Revenue Growth > 12%

(7%)

Fail

Margins

Gross Margin > 35%

23.2%

Fail

 

Net Margin > 15%

(18.5%)

Fail

Balance Sheet

Debt to Equity < 50%

197.7%

Fail

 

Current Ratio > 1.3

1.31

Pass

Opportunities

Return on Equity > 15%

(13.9%)

Fail

Valuation

Normalized P/E < 20

NM

NM

Dividends

Current Yield > 2%

0%

Fail

 

5-Year Dividend Growth > 10%

0%

Fail

       
 

Total Score

 

1 out of 9

Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.

Dynegy only charges up its score for one point. That's a tough spot for a utility company to find itself in, given that shareholders generally expect utilities to deliver solid dividends with reasonable if unexciting profits.

Dynegy's business, however, doesn't resemble traditional utilities like Duke Energy (NYSE: DUK) and Southern (NYSE: SO). During the era of deregulation, some utilities chose to focus solely on either transmission and distribution or on power generation. Dynegy chose production, and as a result, Dynegy and its competitors, which include NRG Energy (NYSE: NRG) and Calpine (NYSE: CPN), have to sell power on the open market to a variety of transmission-focused customers, leaving them exposed to market forces.

Dynegy's woes have brought it to the forefront of potential M&A activity. Last year, Blackstone (NYSE: BX) offered to buy the company for $5 per share, but management turned down the offer. Then, Icahn Enterprises (NYSE: IEP) made a higher offer of $5.50 per share, but billionaire Carl Icahn couldn't get enough shareholders to agree to the deal.

Unfortunately, some analysts think that Dynegy won't survive. GovernanceMetrics International pegged the company's financial distress probability at 10.6%, and the fact that bondholders have sued the company after its restructuring to avoid bankruptcy bodes ill for Dynegy's future prospects.

If Dynegy does come back, it could prove a windfall for stubborn shareholders. But at the moment, it doesn't look likely that Dynegy will become a perfect stock anytime soon.

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 the best investments from the rest.

Click here to add Dynegy 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 doesn't own shares of the companies mentioned. Motley Fool newsletter services have recommended buying shares of Southern. 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.

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