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 USG (NYSE: USG ) 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 USG.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(10.2%)||Fail|
|1-Year Revenue Growth > 12%||8.3%||Fail|
|Margins||Gross Margin > 35%||9.9%||Fail|
|Net Margin > 15%||(9.4%)||Fail|
|Balance Sheet||Debt to Equity < 50%||1764.9%||Fail|
|Current Ratio > 1.3||2.44||Pass|
|Opportunities||Return on Equity > 15%||(90.9%)||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 USG last year, the company has been unable to improve on its one-point showing. Yet the stock has jumped into the stratosphere, picking up about a 125% gain in the past year.
The housing market has been down for so long that many investors seem to think it will never pick up. But after plenty of false starts in previous years, 2012 seems to be shaping up as a year of hope; finally, data on various measures of the housing market are looking better. As a result, long-depressed homebuilder stocks are bouncing back, with Standard Pacific (NYSE: SPF ) more than doubling on optimism for the hard-hit West Coast markets. In addition, related businesses like home-improvement retailers Lowe's (NYSE: LOW ) and Home Depot (NYSE: HD ) have started to see some signs of life, although Lowe's continues to struggle with some internal challenges.
How does USG fit into that picture? USG provides building materials, with a focus on wallboard. Like Mexican cement maven Cemex (NYSE: CX ) as well as Masco (NYSE: MAS ) and its cabinets and plumbing supplies, USG has seen an upswing in sales, with a price increase not hurting the bottom line either.
The problem, though, is that there's only so long that investors will bid up the stock before they'll demand better financial results. So far, the company isn't delivering, with USG reporting only a mild reduction in net losses during this year's second quarter versus the year-ago period. Moreover, both revenue and earnings missed expectations by a wide margin.
For USG to improve, it really needs just one thing: sustained improvement in the housing market that truly translates back into growth. Only once money starts flowing again can USG start to address the bigger challenges of its debt load and weak margins that are the next obstacles on the building materials company's path toward perfection.
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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