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 Peabody Energy (NYSE: BTU ) 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 Peabody Energy.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||16.4%||Pass|
|1-Year Revenue Growth > 12%||18.7%||Pass|
|Margins||Gross Margin > 35%||30.6%||Fail|
|Net Margin > 15%||11.5%||Fail|
|Balance Sheet||Debt to Equity < 50%||114.5%||Fail|
|Current Ratio > 1.3||1.86||Pass|
|Opportunities||Return on Equity > 15%||18.6%||Pass|
|Valuation||Normalized P/E < 20||7.18||Pass|
|Dividends||Current Yield > 2%||1.5%||Fail|
|5-Year Dividend Growth > 10%||7.2%||Fail|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Peabody Energy last year, the company has gained a point. But the stock is down 60% in the past year due to the falling fortunes of the coal sector.
Two macroeconomic factors have rocked the coal industry, and Peabody has gotten taken along for the ride. On one hand, low natural gas prices have encouraged Southern Company (NYSE: SO ) and many other utilities to switch electrical generation away from coal, which will cut 2012 coal consumption by an estimated 120 million tons versus last year. On the other, analysts fear that slowing growth rates in China could hurt demand for metallurgical coal needed for steel. The resulting low prices for coal pushed Patriot Coal into bankruptcy and have punished other big coal companies.
But Peabody has a big advantage over rivals Arch Coal (NYSE: ACI ) and Alpha Natural Resources (NYSE: ANR ) : it's profitable and should stay that way well into the future. By contrast, Alpha and Arch are both expected to lose money both this year and next. One big reason for Peabody's success is that Patriot was a Peabody spinoff that held its eastern U.S. assets, so Peabody essentially kept the more lucrative western-U.S. assets for itself.
Peabody has also taken steps to stand out from the crowd. Its buyout of Australia's Macarthur Coal puts Peabody into the same league as giant BHP Billiton in coal production on the island continent. International exposure puts it in a better strategic position to serve coal-hungry Asian markets.
Moreover, fears about slowing global growth have been greatly overblown. Late last year, Joy Global (NYSE: JOY ) pointed to China's plans to spend $840 billion in power generation and electrical grid infrastructure in the next five years. Meanwhile, India expects a shortfall in coal production that could boost prices.
For Peabody to improve, it needs to work down its debt from the Macarthur acquisition and focus on continuing growth in challenging conditions. It won't be automatic, but Peabody is in a good position to reach for perfection in the long run, and I'm showing my support with a bullish CAPScall on the 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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