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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 Encana (NYSE: ECA ) 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 Encana.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(3.1%)||fail|
|1-Year Revenue Growth > 12%||76.5%||pass|
|Margins||Gross Margin > 35%||68.2%||pass|
|Net Margin > 15%||21.4%||pass|
|Balance Sheet||Debt to Equity < 50%||43.7%||pass|
|Current Ratio > 1.3||1.69||pass|
|Opportunities||Return on Equity > 15%||10.1%||fail|
|Valuation||Normalized P/E < 20||13.13||pass|
|Dividends||Current Yield > 2%||2.7%||pass|
|5-Year Dividend Growth > 10%||26.2%||pass|
|Total Score||8 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of 8, Encana's doing a lot of things right. The Canadian company spun off its oil operations last year into Cenovus Energy (NYSE: CVE ) , leaving Encana more focused on being a giant in natural gas. Encana has taken maximum advantage of recent finds across the continent, yet despite being in good financial shape and paying a nice dividend, the stock remains reasonably valued.
What's surprising about Encana's good showing is that it has major exposure to the struggling natural gas industry. With gas prices remaining stubbornly low, competitor EOG Resources (NYSE: EOG ) recently announced it wouldn't drill any new wells in the promising Barnett shale gas area in 2011. Nevertheless, Encana has retained high hopes for future growth, although even it has had to rein in some of its more ambitious projections going forward in light of $4 natural gas.
Going forward, Encana will have support from a major partner. Just as Anadarko Petroleum (NYSE: APC ) has a joint venture with Mitsui and Chesapeake Energy (NYSE: CHK ) has partnered up with Statoil, Encana has followed suit by pairing up with CNPC, the parent of PetroChina (NYSE: PTR ) , in several of its Canadian projects.
With Encana doing this well even with natural gas prices down in the dumps, the company could put in a perfect 10 if gas prices rebound. Investors will have to wait and see, but in the long run, the future looks bright for Encana.
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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