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 Capstead Mortgage (NYSE: CMO ) 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 Capstead Mortgage.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||59.7%||Pass|
|1-Year Revenue Growth > 12%||25.3%||Pass|
|Margins||Gross Margin > 35%||100%||Pass|
|Net Margin > 15%||91.5%||Pass|
|Balance Sheet||Debt to Equity < 50%||869.3%||Fail|
|Current Ratio > 1.3||0.05||Fail|
|Opportunities||Return on Equity > 15%||12.8%||Fail|
|Valuation||Normalized P/E < 20||11.88||Pass|
|Dividends||Current Yield > 2%||11.1%||Pass|
|5-Year Dividend Growth > 10%||76.2%||Pass|
|Total Score||7 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Capstead Mortgage last year, the company has kept its seven-point score. When you add 10% appreciation in the company's shares over the past year with a double-digit dividend, the mortgage REIT has given investors a nice return.
Capstead doesn't have the brand-name awareness that fellow mortgage REITs Annaly Capital (NYSE: NLY ) and American Capital Agency (Nasdaq: AGNC ) have, but it follows the same basic business model as its better-known peers. By borrowing money to buy mortgage-backed securities, Capstead aims to profit from the spreads across interest rates and return profits to shareholders via dividend payouts. Because of its status as a REIT, Capstead has to pay out most of its income in dividends, explaining the double-digit payout. Although it lags behind the yield of Chimera Investment (NYSE: CIM ) , Capstead invests predominantly in agency-backed securities, leaving riskier assets for Chimera to try to profit from.
This time last year, Capstead enjoyed assurances from the Federal Reserve that it would keep interest rates low until 2013. Now, the Fed has pushed back that deadline even further, with 2014 being the likely date for a first potential rate increase. That could extend the profitable period for Capstead beyond past expectations.
Unfortunately, recent results have indicated potential trouble ahead. Although it didn't suffer American Capital Agency's fate of an actual net loss for its most recent quarter, Capstead joined Invesco Mortgage Capital (NYSE: IVR ) in missing earnings estimates and suffering drops in net income.
Capstead's future lies in what happens to interest rates in general, and the mortgage-security market in particular. Given the leveraged nature of the business model, though, Capstead isn't likely to get any closer to perfection than it already is right now.
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.
Learn more about mortgage REITs by reading the Fool's premium report on Annaly Capital. Many of the same conditions apply to Capstead as well, so take a gander at the Annaly report and find out what you need to know.
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