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 Yongye International (Nasdaq: YONG ) 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 Yongye.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||153.6%||Pass|
|1-Year Revenue Growth > 12%||82.3%||Pass|
|Margins||Gross Margin > 35%||58.5%||Pass|
|Net Margin > 15%||21.7%||Pass|
|Balance Sheet||Debt to Equity < 50%||10.5%||Pass|
|Current Ratio > 1.3||5.44||Pass|
|Opportunities||Return on Equity > 15%||29.6%||Pass|
|Valuation||Normalized P/E < 20||2.37||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||8 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Yongye last year, the company has kept the same eight-point score. Yet its stock price is down 40% over the past year, both reflecting and fueling concerns that the company's financial figures aren't reliable.
Around the world, fertilizer companies have gotten a lot of attention in recent years, as high crop prices and huge demand have pushed up interest in the sector. Until last year, potash-based fertilizer producers Mosaic (NYSE: MOS ) and PotashCorp (NYSE: POT ) had posted impressive gains. Even though Mosaic and PotashCorp have given up ground recently as their costs rise, nitrogen-based fertilizer producers Terra Nitrogen (NYSE: TNH ) and Rentech (AMEX: RTK ) have seen even greater success recently, as their methods avoid some of the high costs that potash production bears. With farmers continuing to project big crop plantings, all four of these companies are in a strong position to benefit from their need to buy fertilizer to improve crop yields.
But Yongye continues to suffer from a crisis of confidence. Because it's a Chinese small cap, many investors are skeptical that Yongye's reported financials reflect reality. The company's most recent earnings report didn't help matters, as Yongye shares took another hit when it revealed that despite its huge revenue growth, outstanding receivables have also soared. Last week, the company said that it had collected more than 90% of the $154 million in outstanding receivables as of the end of 2011, but unless Yongye can keep collecting on unpaid sales made with generous credit terms, its reported numbers could continue to get dinged by further bad-debt provisions.
Yongye needs to find a way to prove to investors once and for all that the results it keeps reporting are real. At current valuations, the best way the company could do that would be to offer to go private. Even if a buyer would have to pay a premium to its current stock price, Yongye's incredibly depressed valuations should make the company an attractive takeover candidate for any buyer that can reach a comfort level about the business.
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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