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 Aetna (NYSE: AET ) 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 Aetna.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||6.0%||Fail|
|1-Year Revenue Growth > 12%||0.9%||Fail|
|Margins||Gross Margin > 35%||29.9%||Fail|
|Net Margin > 15%||5.6%||Fail|
|Balance Sheet||Debt to Equity < 50%||40.1%||Pass|
|Current Ratio > 1.3||0.71||Fail|
|Opportunities||Return on Equity > 15%||18.6%||Pass|
|Valuation||Normalized P/E < 20||7.48||Pass|
|Dividends||Current Yield > 2%||1.8%||Fail|
|5-Year Dividend Growth > 10%||74.7%||Pass|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Aetna last year, the company has kept its four-point score. But the health insurer has faced a lot of uncertainty, which explains the stock's 10% drop over the past year.
For health insurance companies, the huge elephant in the room has been the impact of health-care reform. Although the Supreme Court's decision to uphold the individual mandate provisions of the Affordable Care Act have gotten most of the attention, the boom in the health care industry has brought unsustainable levels of employment growth, which has in turn made the economy increasingly dependent on health care for its overall strength.
With the individual mandate intact, the law has pros and cons for Aetna and peers Humana (NYSE: HUM ) and Cigna (NYSE: CI ) . On one hand, the law forces insurers to limit administrative costs to 20% of premiums, which will put a cap on margin expansion and put a premium on cost control. At the same time, though, a much larger pool of potential customers could give the entire industry a lift.
Last quarter, though, Aetna had some disturbing news, as the insurer missed analyst estimates for earnings per share as rising medical costs ate into net income. By contrast, UnitedHealth Group (NYSE: UNH ) and WellPoint (NYSE: WLP ) beat their estimates and increased their guidance for the full year. The disparity there raises questions about Aetna's ability to keep its costs down, which could eventually threaten its margins.
Aetna has already taken a big step to improve its score, raising its dividend strongly in recent years. But to keep moving forward, Aetna needs to grab onto the growth opportunity that health care reform gives it. Unless it does, Aetna will likely never become a perfect stock.
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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