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 Linn Energy (Nasdaq: LINE ) 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 Linn Energy.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||66.7%||Pass|
|1-Year Revenue Growth > 12%||170.2%||Pass|
|Margins||Gross Margin > 35%||78.1%||Pass|
|Net Margin > 15%||58.5%||Pass|
|Balance Sheet||Debt to Equity < 50%||145.4%||Fail|
|Current Ratio > 1.3||1.13||Fail|
|Opportunities||Return on Equity > 15%||24.7%||Pass|
|Valuation||Normalized P/E < 20||14.28||Pass|
|Dividends||Current Yield > 2%||7.2%||Pass|
|5-Year Dividend Growth > 10%||6.8%||Fail|
|Total Score||7 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Linn Energy last year, the company has picked up a point as its earnings have moved into the black. The company's units have only risen in price by about 5%, but strong dividend income has boosted total returns well above that figure.
Most people have probably never heard of Linn Energy but, as a top-10 oil and gas company, Linn has more than 5 trillion cubic feet of proved gas reserves, and more than 15,500 wells producing a mix of dry gas, oil, and natural gas liquids. Moreover, it has been boosting its production substantially, with 40% growth last year and projections for a further 20% increase this year.
Linn has fostered growth largely through acquisitions. The company has made multiple deals with BP (NYSE: BP ) , as well as Plains Exploration (NYSE: PXP ) and Southwestern Energy (NYSE: SWN ) , in each case focusing on resources with reliable lifespans and good projections for future production.
As Fool analyst Paul Chi observed late last month, Linn has hedged its gas production through 2017, and its oil production through 2016. That makes the company's cash flow extremely predictable, although it also means that the company won't benefit immediately if natural gas prices recover further from their decade lows of earlier this year, and rise above the $4.50 to $5.50 level.
Linn raises some confusion among investors due to its unusual structure. Unlike Enterprise Products Partners (NYSE: EPD ) and many of its midstream peers, Linn is not a master limited partnership. Yet its limited liability company structure gains Linn partnership-tax status, and it pays distributions to unit holders in a way that's very similar to MLPs.
For Linn to improve, the company would need to reduce its leverage and get its balance sheet cleaned up slightly. As long as Linn can keep finding profitable acquisition targets, though, somewhat high levels of debt aren't that worrisome a sign.
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 learn how to separate the best investments from the rest.
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