Has Tesoro 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 Tesoro (NYSE: TSO  ) 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 Tesoro.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

8.4%

Fail

 

1-year revenue growth > 12%

8.5%

Fail

Margins

Gross margin > 35%

7.5%

Fail

 

Net margin > 15%

2.3%

Fail

Balance sheet

Debt to equity < 50%

33.6%

Pass

 

Current ratio > 1.3

1.61

Pass

Opportunities

Return on equity > 15%

17.7%

Pass

Valuation

Normalized P/E < 20

8.91

Pass

Dividends

Current yield > 2%

1.4%

Fail

 

5-year dividend growth > 10%

(5.1%)

Fail

       
 

Total score

 

4 out of 10

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

Since we looked at Tesoro last year, the company has held onto all three points it gained from 2011 to 2012. The stock has absolutely soared, up about 120% over the past year.

Tesoro has enjoyed perfect conditions in the refining industry lately. Because of the massive rise in production of domestic crude, refineries that obtain oil supplies that are priced based on West Texas Intermediate benchmarks have enjoyed high margins compared to peers that have to rely on imported oil using higher-cost Brent crude. Moreover, refined-product pricing has been extremely favorable, leading to a powerful combination for profit growth.

In response to these conditions, Tesoro has put its profits to work, inking a deal that made it the largest refiner on the West Coast. The $2.5 billion deal with BP (NYSE: BP  ) includes not only an increase to the company's refining capacity but also more than 800 Arco gas stations to Tesoro's marketing arm. Yet the acquisition is still on hold pending a close look from regulators concerned about potential antitrust issues.

In its most recent quarter, Tesoro missed earnings estimates even though it was able to raise its refining margins substantially from the year-ago period. But looking forward, Tesoro's plans to lock in rail transport to bring cheap domestic crude to its refineries on the West Coast should help it capitalize on favorable price differentials compared to imported Brent crude. Phillips 66 (NYSE: PSX  ) has made a similar rail-based move to bring cheap oil to the East Coast that also promises a positive impact on profits, and Tesoro expects the same gains.

For Tesoro to improve, it needs to keep working on profitable growth and then consider boosting dividend payouts to shareholders. As long as favorable pricing conditions last, Tesoro should keep delivering strong returns to investors.

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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