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 Moody's (NYSE: MCO ) 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 Moody's.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||3.5%||Fail|
|1-Year Revenue Growth > 12%||16.6%||Pass|
|Margins||Gross Margin > 35%||70%||Pass|
|Net Margin > 15%||26.9%||Pass|
|Balance Sheet||Debt to Equity < 50%||NM||NM|
|Current Ratio > 1.3||1.63||Pass|
|Opportunities||Return on Equity > 15%||NM||NM|
|Valuation||Normalized P/E < 20||14.60||Pass|
|Dividends||Current Yield > 2%||1.7%||Fail|
|5-Year Dividend Growth > 10%||13.6%||Pass|
|Total Score||6 out of 8|
Source: S&P Capital IQ. NM = not meaningful; Moody's has negative shareholder equity. Total score = number of passes.
With six points, Moody's has held up reasonably well through the financial crisis. Given its position as one of the scapegoats for the mortgage mess, Moody's nevertheless has retained its status as one of the most powerful companies in the world.
Moody's is infamous for being one of the select few companies that issue bond ratings on government and corporate debt. Along with Fitch Ratings and the Standard & Poor's division of McGraw-Hill (NYSE: MHP ) , Moody's issues ratings that institutional investors around the world use to evaluate and price trillions of dollars' worth of securities. The reaction to S&P's downgrade of U.S. government debt is just the latest example of how much investors depend on these ratings.
But many have found fault with the process Moody's used to rate securities. Detractors point to ratings flubs on insurance giant AIG (NYSE: AIG ) and Lehman Brothers as evidence that the company fell asleep at the wheel during the mortgage meltdown. Its triple-A rating of a Goldman Sachs (NYSE: GS ) mortgage-backed securities portfolio provides a more direct link to the role Moody's played in the crisis.
Nevertheless, in many ways, times have never been better for Moody's. With bond issuance at extremely high levels, the company continues to earn money to provide ratings for those bonds. Without a sea change in the way the bond markets operate, that situation is likely to continue for the foreseeable future.
In many ways, Moody's long-term prospects depend on the health of big banks like Citigroup (NYSE: C ) and Bank of America (NYSE: BAC ) . If banks resolve their remaining problems favorably, then it will be far easier for investors to write off the financial crisis as a one-time event. If new problem arise, though, then Moody's may never get its full credibility back -- let alone become a perfect stock.
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."