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 NorthStar Realty Finance (NYSE: NRF ) 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 NorthStar Realty Finance.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||35.9%||Pass|
|1-Year Revenue Growth > 12%||308.6%||Pass|
|Margins||Gross Margin > 35%||89.1%||Pass|
|Net Margin > 15%||(122.7%)||Fail|
|Balance Sheet||Debt to Equity < 50%||336.4%||Fail|
|Current Ratio > 1.3||1.60||Pass|
|Opportunities||Return on Equity > 15%||(31.9%)||Fail|
|Valuation||Normalized P/E < 20||4.12||Pass|
|Dividends||Current Yield > 2%||11.3%||Pass|
|5-Year Dividend Growth > 10%||(18.9%)||Fail|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at NorthStar Realty Finance last year, the real estate investment trust has picked up a couple of points, as normalized net income -- which excludes losses from investment sales -- and revenue growth have improved over the past year. NorthStar is benefiting from the same trends that have helped other leveraged REITs, but it's important to understand that NorthStar differs markedly from many of its high-yielding peers.
When investors see double-digit dividend yields from a REIT, they immediately assume that it must be in the same class as REITs like Annaly Capital (NYSE: NLY ) , American Capital Agency (Nasdaq: AGNC ) , or ARMOUR Residential (NYSE: ARR ) . But while NorthStar has some of the same characteristics as those mortgage REITs, including high leverage, it invests in commercial real estate, both through commercial-mortgage-backed securities as well as through direct loans and leases to corporate tenants. As such, NorthStar doesn't have the residential exposure that most mortgage REITs have.
That's not to say that NorthStar is the only REIT in the commercial business. It faces plenty of competition from the likes of Crexus Investment (NYSE: CXS ) and Starwood Property Trust (NYSE: STWD ) . Yet compared to its competitors, NorthStar maintains a far higher leverage ratio.
With that leverage, NorthStar benefits from current low interest rates. Yet it also puts NorthStar in the same uncertain position as its residential mortgage REIT counterparts, with talk of new laws and regulation potentially forcing leverage reduction or taking away the tax advantages of REIT status.
Going forward, NorthStar needs to focus on reversing a long string of bad investments that it has had to write down, creating GAAP losses. If it can use the current favorable environment to boost its cash from operations, NorthStar could get closer to perfection in the next year.
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."