Has SeaDrill 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 and then decide whether Seadrill (NYSE: SDRL  ) 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.
  • Moneymaking 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 Seadrill.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

21.1%

Pass

 

1-year revenue growth > 12%

0.9%

Fail

Margins

Gross margin > 35%

61.6%

Pass

 

Net margin > 15%

23.8%

Pass

Balance sheet

Debt to equity < 50%

177.7%

Fail

 

Current ratio > 1.3

0.79

Fail

Opportunities

Return on equity > 15%

16.5%

Pass

Valuation

Normalized P/E < 20

40.36

Fail

Dividends

Current yield > 2%

9%

Pass

 

5-year dividend growth > 10%

27.7%

Pass

       
 

Total score

 

6 out of 10

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

Since we looked at Seadrill last year, the company has lost a point for the second year in a row, this time as revenue growth slowed. The shares managed a minimal rise of about 5% over the past year, not including the substantial dividends that the stock paid out as well.

Seadrill has tapped into the lucrative ultra-deepwater drilling segment, which has entirely different dynamics from traditional land-based drilling. With onshore rigs, drilling can be done in a matter of days, which can lead to fast and severe fluctuations in demand. But Seadrill and rival Transocean (NYSE: RIG  ) benefit from contracts that can extend for years, given that each individual well can take months to drill and complete. Transocean has 10-year contracts with some of its customers for rigs that aren't even built yet, while Seadrill has half of its fleet locked up through 2017.

In particular, Seadrill has hitched itself to some promising long-term offshore plays. Petrobras (NYSE: PBR  ) has contracted several submersible rigs to develop its Santos and Campos Basin holdings off the coast of Brazil, while similar plays across the Atlantic off the west coast of Africa have similar promise.

Most interesting is Seadrill's decision to offer shares of Seadrill Partners (NYSE: SDLP  ) as a way to get direct exposure to particular drilling rigs. Yet despite the word "partners" in the name, the entity is organized as a limited liability company and has elected to be taxed as a corporation, removing many of the benefits that master limited partnerships enjoy. With the dividend yield below that of the original company, Seadrill Partners doesn't appear to pose a threat to Seadrill's attractiveness as an investment.

For Seadrill to improve, it needs to get its debt under control and work on boosting revenue further. Continued growth should push normalized earnings up and bring valuations down, but until that happens, Seadrill may not get much closer to perfection.

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.

Learn more about Seadrill by reading our full-length premium report on the stock. It's one of the most exciting plays in the space, and our top analysts have drilled down on the company to find out whether Seadrill is a buy right now. Click here to get started.

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


Read/Post Comments (2) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 03, 2013, at 6:48 PM, jaybird43 wrote:

    If this stock had a p/e of 40, it would not be in my portfolio. Please explain how you arrived at that!

  • Report this Comment On February 06, 2013, at 12:55 PM, turnermuseum wrote:

    Despite its foolish short-comings this foolish investor applauds this contribution.

    Strongly disagree your assessment that the Balance Sheet FAILS on TWO accounts, I guess, because it is highly leveraged. Stuff + foolishness! Wise debt at SDRL means money making opportunities. Specifically 200-300%, or more, on the amount borrowed.

    Thus only a truly foolish investor would object to high leverage which equals higher future profits + ultimately higher cash dividends.

    A not so foolish trade mark of a truly "ideal" stock!

    PS

    Are you claiming SDRL's PER is 40?

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