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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 KB Home (NYSE: KBH ) 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 KB Home.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(32.5%)||Fail|
|1-Year Revenue Growth > 12%||(17.2%)||Fail|
|Margins||Gross Margin > 35%||17.3%||Fail|
|Net Margin > 15%||(13.6%)||Fail|
|Balance Sheet||Debt to Equity < 50%||357.7%||Fail|
|Current Ratio > 1.3||6.88||Pass|
|Opportunities||Return on Equity > 15%||(33.3%)||Fail|
|Valuation||Normalized P/E < 20||NM||NM|
|Dividends||Current Yield > 2%||2.2%||Pass|
|5-Year Dividend Growth > 10%||(24.2%)||Fail|
|Total Score||2 out of 9|
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
Since we looked at KB Home last year, the company has gained a point. Despite its dividend rising above 2%, however, the homebuilder has a long way to go to get back to its former glory.
Home prices have struggled for years, and even recent figures show big declines in most cities around the country. Clearly, that has had an impact throughout the economy, especially for homebuilders.
But after years of record-low housing starts, some signs are appearing that suggest the glut in new homes may finally be starting to dissipate. New orders are starting to pour in, with Lennar (NYSE: LEN ) seeing 20% growth in new orders. Even higher-end homebuilder Toll Brothers (NYSE: TOL ) posted an 8% gain, while KB Home saw orders jump 38%.
Backlog units are also on the rise, with KB Home sporting a 22% rise. Competitors Beazer Homes (NYSE: BZH ) and Standard Pacific (NYSE: SPF ) had even bigger jumps in backlogs, at 84% and 40%, respectively.
Still, KB Home and its peers have a long way to go before they can return to their heyday. KB Home's revenue stands at just 15% of its 2006 peak, and it's obviously a long way from profitability.
To improve its score, KB Home needs to take things one step at a time. Once revenue hits bottom, the company can start focusing on getting its margins up, and then turn its attention to its balance sheet. The housing boom of the 2000s may never return, but KB Home could still survive in better shape than it's been in during the recession.
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 the best investments from the rest.
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