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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 Encana (NYSE: ECA ) 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 Encana.
What We Want to See
Pass or Fail?
|Growth||5-year annual revenue growth > 15%||(14.2%)||Fail|
|1-year revenue growth > 12%||(26.7%)||Fail|
|Margins||Gross margin > 35%||60.8%||Pass|
|Net margin > 15%||3.1%||Fail|
|Balance sheet||Debt to equity < 50%||52.2%||Fail|
|Current ratio > 1.3||0.81||Fail|
|Opportunities||Return on equity > 15%||1.4%||Fail|
|Valuation||Normalized P/E < 20||169.69||Fail|
|Dividends||Current yield > 2%||4.1%||Pass|
|5-year dividend growth > 10%||18%||Pass|
|Total score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since last year, Encana has fallen from grace, losing five full points. Drops in net margins, contracting sales, and a weakening balance sheet have all weighed on the energy company over the past year.
Like peers EOG Resources (NYSE: EOG ) and Southwestern Energy (NYSE: SWN ) , Encana is one of many companies that have struggled in the weak natural gas industry. New finds have boosted production, pushing prices into the doldrums and hurting Encana's prospects. Yet unlike rivals Chesapeake Energy (NYSE: CHK ) and SandRidge (NYSE: SD ) , which have moved away from natural gas toward the more lucrative oil market, Encana doubled down by divesting itself of its oil business two years ago to focus exclusively on natural gas.
Now, Encana has continued its asset purge. By selling properties in North Texas, Colorado, and British Columbia recently to buyers such as Enbridge (NYSE: ENB ) , Encana has raised cash to help deal with its debt load. The newly missing pieces of Encana's puzzle help explain the massive drop in revenue.
In its most recent quarter, though, Encana managed to double its operating earnings and boost its production by 6%, in line with its own internal targets. Going forward, Encana hopes to cash in on the growing interest in gas liquids, which are more lucrative than regular natural gas. Even if it's successful, the company has a long way to go to return to the near perfection it enjoyed not long ago.
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.
Click here to add Encana to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.
Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."