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 Embraer (NYSE: ERJ ) 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 Embraer.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||4.4%||Fail|
|1-Year Revenue Growth > 12%||8.5%||Fail|
|Margins||Gross Margin > 35%||22.3%||Fail|
|Net Margin > 15%||0.9%||Fail|
|Balance Sheet||Debt to Equity < 50%||77.1%||Fail|
|Current Ratio > 1.3||1.72||Pass|
|Opportunities||Return on Equity > 15%||2.0%||Fail|
|Valuation||Normalized P/E < 20||58.59||Fail|
|Dividends||Current Yield > 2%||1.9%||Fail|
|5-Year Dividend Growth > 10%||(17.6%)||Fail|
|Total Score||1 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Embraer last year, the company has lost three points. Plunging profits and a drop in its dividend account for the score loss, and shareholders have also suffered, with a 15% fall in the stock price in the past year.
Embraer is the third largest aircraft maker in the world next to Boeing (NYSE: BA ) and Airbus, and its home country of Brazil has seen some amazing growth in recent years. Along with rival Bombardier, Embraer specializes in smaller jets that are popular in regional airlines and for secondary-market routes. Those planes have been highly in demand as airlines look to become more efficient on lower-demand flights.
But more recently, Embraer has had some struggles. Cancelled orders, a lack of new sales, and a lack of success at the industry's landmark Farnborough Airshow earlier this month sent the stock tumbling. More troubling is the impact that the drop in backlog could have on future earnings. The company has responded by talking directly with AMR and Delta Air Lines (NYSE: DAL ) about potential orders for its E175 aircraft, but nothing has come of those talks as of yet. Meanwhile, Bombardier has been full of activity, with a big order for Berkshire Hathaway (NYSE: BRK-A ) (NYSE: BRK-B ) subsidiary NetJets.
Some even believe that Embraer would be a logical takeover target for Boeing. With the U.S. aircraft maker seeking to get inroads into the Brazilian market, a buyout could well make sense for Boeing, as it could add some international diversification on the defense side of its business as well as boosting its competitive position against Airbus on the commercial side. The companies are already working together on the KC-390 aircraft program and also plan an alliance on the Super Tucano jet program.
For Embraer to improve, a rebound in the slowing Brazilian economy as well as stronger activity in Europe and other troubled areas would go a long way to helping the aircraft maker. Nevertheless, it could be a long time before Embraer gets close to becoming a perfect stock.
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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