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 American Water Works (NYSE: AWK ) 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 American Water Works.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||5.5%||Fail|
|1-Year Revenue Growth > 12%||3.6%||Fail|
|Margins||Gross Margin > 35%||52.2%||Pass|
|Net Margin > 15%||12.1%||Fail|
|Balance Sheet||Debt to Equity < 50%||130.4%||Fail|
|Current Ratio > 1.3||0.79||Fail|
|Opportunities||Return on Equity > 15%||7.5%||Fail|
|Valuation||Normalized P/E < 20||18.49||Pass|
|Dividends||Current Yield > 2%||3.0%||Pass|
|5-Year Dividend Growth > 10%||3.6%*||Fail|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes. * Four-year growth rate.
Since we looked at American Water Works last year, the company has lost a point. Slowing revenue growth over the past year cost the company the point, but a gain in the stock of more than 15% has shareholders fairly pleased with its results.
With record droughts recently, investors have started paying a lot more attention to water suppliers. Within the highly fragmented industry, American Water Works is a major player with a substantial geographical presence, with operations across the U.S. as well as in parts of Canada.
Future growth may come from consolidation. With smaller companies California Water Service (NYSE: CWT ) and SJW covering relatively small areas, you can expect to see American Water Works fight with Aqua America (NYSE: WTR ) to grow through acquisitions of these and other small local water utilities. Boosting its size is a good way to try to hold off big international player Veolia Environnement (NYSE: VE ) as it retrenches its international operations.
But another interesting opportunity may come from supplying water to natural gas producers using hydraulic fracturing. Heckmann (NYSE: HEK ) is cashing in on not only providing water but also handling wastewater and dealing with all the permitting procedures needed to help drillers get the job done. With American Water Works covering many areas where fracking looks to have potential, it has an opportunity to cover that niche area itself.
For American Water Works to improve, it needs to capture more than its fair share of these growth prospects. If it can do so, then it can start paying down debt and moving closer to perfection bit by bit.
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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