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 Apollo Investment (Nasdaq: AINV ) 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 Apollo Investment.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||13.6%||Fail|
|1-Year Revenue Growth > 12%||10.1%||Fail|
|Margins||Gross Margin > 35%||100%||Pass|
|Net Margin > 15%||(18.7%)||Fail|
|Balance Sheet||Debt to Equity < 50%||76.8%||Fail|
|Current Ratio > 1.3||0.93||Fail|
|Opportunities||Return on Equity > 15%||(4.1%)||Fail|
|Valuation||Normalized P/E < 20||12.30||Pass|
|Dividends||Current Yield > 2%||14.1%||Pass|
|5-Year Dividend Growth > 10%||(9.2%)||Fail|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With a score of only three points, Apollo Investment looks like it has some work to do. But as a business development company, Apollo doesn't entirely fit the same set of criteria that you use to judge regular stocks.
Business development companies are tax-favored entities that make private investments in small businesses. In particular, Apollo focuses largely on providing debt financing to companies through secured loans. To obtain their preferential tax status, BDCs have to distribute most of their income to shareholders in the form of dividends, which explains Apollo's high yield.
But one controversial practice that Apollo and other BDCs engage in is getting authorization from shareholders to issue new shares at less than the current net value of their assets. Apollo, Ares Capital (Nasdaq: ARCC ) , and Prospect Capital (Nasdaq: PSEC ) all asked for authority to do so last year, and typically, shareholders allow it -- even though it potentially dilutes their interest in the company.
In addition, you have to be ready to suffer through tough times without any dividend at all. American Capital (Nasdaq: ACAS ) , for instance, suspended its dividend in late 2008 and hasn't paid one since. So far, Apollo has done a good job of keeping its payout stable, but there's no guarantee the good times will continue forever.
With trailing-12-month returns on equity having gone negative for the first time in two years last quarter, Apollo faces challenges from the losses on sales of investments it has made recently. To get closer to perfection, Apollo needs to reverse that trend. If it can start earning gains on its investment sales, then it'll be easier for Apollo to maintain its highly attractive dividend.
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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