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 TRW Automotive (NYSE: TRW ) 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 TRW Automotive.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||4.2%||Fail|
|1-Year Revenue Growth > 12%||13.6%||Pass|
|Margins||Gross Margin > 35%||11.7%||Fail|
|Net Margin > 15%||5.9%||Fail|
|Balance Sheet||Debt to Equity < 50%||54.4%||Fail|
|Current Ratio > 1.3||1.19||Fail|
|Opportunities||Return on Equity > 15%||40.6%||Pass|
|Valuation||Normalized P/E < 20||5.36||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With only three points, TRW Automotive isn't driving forward very fast. The recovery in the auto industry poses a mixed bag for the parts industry, and TRW still faces plenty of competition.
TRW provides a wide variety of auto parts to both carmakers and consumers. Its safety division, which makes airbags and seat belts, competes directly with Autoliv (NYSE: ALV ) , while its after-market parts go up against companies like Advance Auto Parts (NYSE: AAP ) and Magna International (NYSE: MGA ) .
Recently, new car sales have picked up. Chrysler, Ford (NYSE: F ) , and General Motors (NYSE: GM ) all reported higher sales in November, with Chrysler in particular jumping more than 44% -- the sixth straight month it beat the 20% level. Even disaster-ravaged Toyota (NYSE: TM ) managed to post a gain for the month, its first in nine months.
That in turn has had an impact on TRW. Stronger new car sales mean more demand from automakers, although there's an offsetting impact: newer cars mean fewer consumers wanting after-market parts.
One concern that shareholders need to consider is that TRW CEO John Plant recently made a list of top-paid corporate leaders -- despite the stock having fallen more than 40% this year. With some bonuses carrying little or no link to performance, shareholders should watch out to make sure Plant's interests align with theirs.
For TRW to get better, it needs to improve its balance sheet and work toward improving margins as the auto industry ramps up. If it can't, then TRW may never 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."