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Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?
One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Precision Drilling (NYSE: PDS ) fits the bill.
The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.
Some of the most basic yet important things to look for in a stock are:
- 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 don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
- Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
- Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
- Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. 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 Precision Drilling.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||2.1%||fail|
|1-Year Revenue Growth > 12%||2.7%||fail|
|Margins||Gross Margin > 35%||37.4%||pass|
|Net Margin > 15%||2.5%||fail|
|Balance Sheet||Debt to Equity < 50%||26.1%||pass|
|Current Ratio > 1.3||3.37||pass|
|Opportunities||Return on Equity > 15%||1.2%||fail|
|Valuation||Normalized P/E < 20||27.45||fail|
|Dividends||Current Yield > 2%||0%||fail|
|5-Year Dividend Growth > 10%||NM*||fail|
|Total Score||3 out of 10|
Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful; Precision Drilling cut its dividend in 2009. Total score = number of passes.
With a score of 3, Precision Drilling is far from perfect. But after having gone through a tough couple of years, the company just may be starting to turn around.
Two events conspired to put the hurt on Precision. First, natural gas prices staged a huge decline, which forced cutbacks on the gas drilling activity that's Precision's stock in trade. In addition, the Canadian government announced it was eliminating the favorable tax status of Canadian royalty trusts like Precision.
Precision has had a tough time with the transition. Unlike fellow converted Canroys Penn West Energy (NYSE: PWE ) , Pengrowth Energy (NYSE: PGH ) , and Enerplus Resources (NYSE: ERF ) , which have all been able to keep paying dividends even with the coming rule change, Precision slashed its dividend in order to restructure its balance sheet.
Now, Precision's efforts are starting to bear fruit. It's reduced its debt levels and obtained better interest rates on what's left outstanding. It's also tried to diversify away from its former natural gas focus, which could give it some relief from stubbornly low prices for the clean-burning fuel. In the most recent quarter, those initiatives helped push sales up 42%.
It's been a hard period for Precision Drilling. But with a lot of the hard work already behind the company, the stock may move a lot closer toward perfection in the years ahead.
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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