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 Hercules Offshore (Nasdaq: HERO ) 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 Hercules Offshore.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||9.9%||Fail|
|1-Year Revenue Growth > 12%||(0.1%)||Fail|
|Margins||Gross Margin > 35%||31.2%||Fail|
|Net Margin > 15%||(15.7%)||Fail|
|Balance Sheet||Debt to Equity < 50%||85.2%||Fail|
|Current Ratio > 1.3||1.72||Pass|
|Opportunities||Return on Equity > 15%||(10.1%)||Fail|
|Valuation||Normalized P/E < 20||NM||NM|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||1 out of 9|
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
Since we looked at Hercules Offshore last year, the company has dropped two points. Falling sales growth and gross margins are to blame, as the stock has dropped about 30% in the past year.
At first glance, Hercules ought to have everything going for it. With relatively high energy prices and a huge amount of offshore drilling activity, competitors Seadrill (NYSE: SDRL ) and Transocean (NYSE: RIG ) have realized amazing growth from all the deepwater projects happening around the world. Even Noble (NYSE: NE ) has gotten into the deepwater drilling game recently.
But Hercules is a shallow-water driller, and that segment hasn't done nearly as well. Diamond Offshore (NYSE: DO ) has had idled rigs in the Gulf that have hampered its performance, and Hercules has had its own trouble getting utilization up. Although dayrates have risen slightly, it's nothing compared to what deepwater drillers have seen.
The other challenge that Hercules faces is its debt. With substantial interest expense, Hercules will struggle to become profitable, let alone pay the lucrative dividends that you'll find among the deepwater drillers.
For Hercules to improve, it needs to start looking into deepwater projects. Until shallow-water drilling becomes popular again, Hercules will have problems moving toward perfection without a strategic shift.
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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