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 Diamond Offshore (NYSE: DO ) 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 Diamond Offshore.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||7.8%||Fail|
|1-Year Revenue Growth > 12%||1.5%||Fail|
|Margins||Gross Margin > 35%||50.8%||Pass|
|Net Margin > 15%||27.9%||Pass|
|Balance Sheet||Debt to Equity < 50%||34.0%||Pass|
|Current Ratio > 1.3||5.2||Pass|
|Opportunities||Return on Equity > 15%||21.4%||Pass|
|Valuation||Normalized P/E < 20||12.72||Pass|
|Dividends||Current Yield > 2%||5.5%*||Pass|
|5-Year Dividend Growth > 10%||(4.9%)*||Fail|
|Total Score||7 out of 10|
Source: S&P Capital IQ. Total score = number of passes. *Includes special dividends.
Since we looked at Diamond Offshore last year, the company has dropped two points. Falling revenue growth is a concern, although the stock has only dropped by about 10% over the past year.
The drilling industry these days is a tale of two markets. For Ocean Rig UDW (Nasdaq: ORIG ) and Seadrill (NYSE: SDRL ) , which have exposure to deepwater and ultra-deepwater drilling, prospects have been relatively bright.
But with shallow-water drilling, the story is much different. Hercules Offshore (Nasdaq: HERO ) and Diamond have struggled with their shallow-water drilling assets in the Gulf of Mexico, many of which have stood idle for some time. Even Transocean (NYSE: RIG ) has seen weakness in its Gulf rigs, despite having plenty of exposure to deepwater.
Still, improving conditions in the shallow-drilling market might leave Diamond poised for a turnaround. Recently, day rates for shallow-water rigs have risen slightly. One way the company is trying to recover is to move into more promising markets. Its recent sale of its Ocean Columbia rig to Hercules gave Diamond some valuable cash, which should make that move easier.
For Diamond to improve, it needs to get its growth engines turned back on. With oil prices starting to retreat, that could be a tall order, as many of the more expensive drilling projects need high energy prices to justify their costs. Nevertheless, Diamond appears to be positioning itself to take advantage of the huge finds around the world recently, and if it gets its fair share, it could move back toward perfection in the near future.
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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