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 Noranda Aluminum (NYSE: NOR ) 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 Noranda Aluminum.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||3.8%||Fail|
|1-Year Revenue Growth > 12%||32.7%||Pass|
|Margins||Gross Margin > 35%||16%||Fail|
|Net Margin > 15%||9.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||117.1%||Fail|
|Current Ratio > 1.3||1.79||Pass|
|Opportunities||Return on Equity > 15%||57.8%||Pass|
|Valuation||Normalized P/E < 20||3.95||Pass|
|Dividends||Current Yield > 2%||1.4%||Fail|
|5-Year Dividend Growth > 10%||NM||NM|
|Total Score||4 out of 9|
Source: S&P Capital IQ. NM = not meaningful; Noranda initiated a regular dividend earlier this month. Total score = number of passes.
With a score of 4, Noranda Aluminum comes in a little light. The small aluminum maker has a much narrower focus than most of its competitors.
When most people think of aluminum, they think of big companies like Alcoa (NYSE: AA ) , Chinalco (NYSE: ACH ) , and Rio Tinto (NYSE: RIO ) , which serve a wide variety of needs from aircraft manufacture to aluminum cans. But Noranda has a couple of key niche markets that it serves: aluminum foil and pie-tin production, as well as heat-exchanger fins.
In the past year, Noranda has grown much faster than fellow small aluminum makers Kaiser Aluminum (Nasdaq: KALU ) and Century Aluminum (Nasdaq: CENX ) . But Noranda also carries quite a bit more debt than Kaiser or Century, which partially contributes to higher returns on equity. Also, one main reason why the company's earnings multiple is so low is because it had profits from hedging operations -- something that investors shouldn't count on repeating.
The main concern for Noranda is softness in the global economy. With Europe posing macroeconomic threats, industrial activity could drop, leading to reduced aluminum demand. But with the company having just initiated a regular dividend for the first time, the company clearly thinks those fears are exaggerated.
The key for Noranda to improve is to get its debt situation better under control -- even at the expense of leveraged returns. In the long run, a healthier balance sheet would help get Noranda closer to 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."