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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 Radian Group (NYSE: RDN ) 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 Radian Group.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(0.8%)||Fail|
|1-Year Revenue Growth > 12%||(23.8%)||Fail|
|Margins||Gross Margin > 35%||5.0%||Fail|
|Net Margin > 15%||(18.8%)||Fail|
|Balance Sheet||Debt to Equity < 50%||86.0%||Fail|
|Current Ratio > 1.3||4.75||Pass|
|Opportunities||Return on Equity > 15%||(22.3%)||Fail|
|Valuation||Normalized P/E < 20||NM||NM|
|Dividends||Current Yield > 2%||0.3%||Fail|
|5-Year Dividend Growth > 10%||(34.0%)||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 Radian Group last year, the company has lost a point. The stock has been all over the place in the past year, but shares are more than 10% higher than they were a year ago despite a substantial drop in revenue.
Radian Group is in the mortgage insurance business, and after the housing bust, it's hard to think of a business you'd want to be in less. Liability from insurance policies helped drive Ambac Financial into bankruptcy, and it knocked Radian and its peers for a big loop. But Radian did manage to reduce its risk by selling off its municipal bond insurance unit to rival Assured Guaranty (NYSE: AGO ) earlier this year.
During the spring, things started looking better for the mortgage insurance industry. Radian, Genworth Financial (NYSE: GNW ) , and MGIC Investment (NYSE: MTG ) all reported a significant pickup in business during April, nearly doubling the value of policies written compared to the previous year. New insurers even entered the field to take advantage of renewed mortgage activity.
Fears in the industry have arisen again, however, after MGIC reported a much wider loss for its second quarter than for the year-ago quarter. MGIC's revenue fell despite increased policy volumes. Genworth and Old Republic (NYSE: ORI ) have been trying to sell off their mortgage insurance divisions, but neither company has been successful in doing so. None of this news is reassuring to Radian shareholders.
One potential source for new business, though, may come from proposed new rules requiring that banks provide information on fee-free refinancing. If the move spurs more refinancing activity, Radian could have more mortgages to insure, boosting revenue.
For Radian to improve, it really needs the housing market to find some stability. Once that happens, the mortgage insurer will be in a better position to start raking in bigger profits unencumbered by significant risk of loss.
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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