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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 Tesoro (NYSE: TSO ) 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 Tesoro.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||10.7%||Fail|
|1-Year Revenue Growth > 12%||47.8%||Pass|
|Margins||Gross Margin > 35%||5.9%||Fail|
|Net Margin > 15%||1.8%||Fail|
|Balance Sheet||Debt to Equity < 50%||42.8%||Pass|
|Current Ratio > 1.3||1.28||Fail|
|Opportunities||Return on Equity > 15%||15.7%||Pass|
|Valuation||Normalized P/E < 20||6.66||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Tesoro last year, the refiner has rebounded sharply, quadrupling its score. A return to profitability along with reductions in overall debt and faster revenue growth explain the boost.
The refining industry has gone through a lot of changes lately. Marathon Oil chose to spin off its refining operations into Marathon Petroleum (NYSE: MPC ) , while ConocoPhillips plans to follow suit shortly. Both Conoco and Sunoco (NYSE: SUN ) are trying to sell East Coast refineries, with Sunoco going so far as to shut down operations to conserve cash.
Yet on the West Coast, the story is different. With Western Refining (NYSE: WNR ) and HollyFrontier (NYSE: HFC ) closer to their sources of crude, they benefit from the boom in domestic oil production in a way that East Coast refineries can't.
In particular, Tesoro benefited from the spread between prices of West Texas Intermediate versus Brent crude. Those spreads helped improve margins and cut input costs for producing refined products. Although the WTI-Brent spread has been volatile, it remains at fairly significant levels.
For Tesoro to continue seeing improvement, it needs energy prices to keep cooperating. Higher gasoline prices are generally favorable for refiner margins, but if they get high enough to start curbing demand, they'll eventually pinch Tesoro's profits.
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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