Has Dow Chemical Become the Perfect Stock?

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 Dow Chemical (NYSE: DOW  ) 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 Dow Chemical.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

2.0%

Fail

 

1-Year Revenue Growth > 12%

(4.5%)

Fail

Margins

Gross Margin > 35%

15.6%

Fail

 

Net Margin > 15%

3.3%

Fail

Balance Sheet

Debt to Equity < 50%

81.3%

Fail

 

Current Ratio > 1.3

1.83

Pass

Opportunities

Return on Equity > 15%

7.7%

Fail

Valuation

Normalized P/E < 20

15.67

Pass

Dividends

Current Yield > 2%

4.6%

Pass

 

5-Year Dividend Growth > 10%

(6.4%)

Fail

       
 

Total Score

 

3 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Dow Chemical last year, the company has given back one of the points it earned from 2010 to 2011. But the stock has only managed about a 5% gain over the past year.

Dow has a diversified business that includes chemicals as well as electronic materials, plastics, and agricultural productivity solutions. That has helped the company ride out the volatile business cycle, especially with conditions in the agricultural industry have been extremely strong. Both DuPont (NYSE: DD  ) and Monsanto (NYSE: MON  ) have seen huge growth in their ag divisions over the past several years, thanks to higher crop prices and farmers being relatively flush with cash flow to spend on yield-increasing products.

Dow's most recent quarter certainly wasn't anything to write home about, with revenue falling 10% and earnings posting a 39% decline. Once again, though, the ag sciences division was the exception to the rule, posting a rise in revenue by 8%. Investors were also pleased with plans to cut costs, including a 2,400-job layoff that amounts to about 5% of Dow's workforce. Compared to DuPont's smaller layoff, Dow is taking stronger steps toward shoring up its financials for the future.

One area that has done an about-face for several players in the chemicals industry is the titanium dioxide market. After a long period of high demand for the pigment, DuPont has seen much lower volumes for TiO2. Rivals Huntsman (NYSE: HUN  ) and Kronos Worldwide (NYSE: KRO  ) have also seen lower TiO2 pressure their margins, even as paint suppliers have largely been able to pass through past price increases to their customers. Although Dow doesn't produce titanium dioxide itself, it does make products that include the pigment, as well as others that help paint manufacturers use less titanium dioxide in their production processes.

For Dow to improve, it needs to get a better handle on its finances to wring better returns on equity from its business. That could help Dow get a little closer to perfection even in a low-margin, low-growth environment.

Keep searching
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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Click here to add Dow Chemical to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Editor's note: A previous version of this article said that Dow produced titanium dioxide. The Fool regrets the error.



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