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 and then decide whether Home Inns & Hotels (Nasdaq: HMIN ) 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.
- Moneymaking 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 Home Inns & Hotels.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||46%||Pass|
|1-Year Revenue Growth > 12%||49.8%||Pass|
|Margins||Gross Margin > 35%||31.4%||Fail|
|Net Margin > 15%||2.6%||Fail|
|Balance Sheet||Debt to Equity < 50%||52.8%||Fail|
|Current Ratio > 1.3||0.87||Fail|
|Opportunities||Return on Equity > 15%||4%||Fail|
|Valuation||Normalized P/E < 20||26.97||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||2 out of 10|
Source: S&P Capital IQ. NM = not meaningful because of negative earnings. Total score = number of passes.
Since we looked at Home Inns & Hotels last year, the company has seen its score plunge by 3 points. Drops in margins and greater debt on the balance sheet were responsible for the decline, and the stock's fall of roughly 25% over the past year seems to reflect the same uncertainty despite substantial revenue gains.
For a while now, a rising consumer class in China has bolstered the travel industry there. Online travel portal Ctrip.com (Nasdaq: CTRP ) has experienced substantial sales volume increases as more Chinese residents chose to take tours and stay in hotels. At the same time as Marriott (NYSE: MAR ) and other overseas operators have sought to expand in China, that demand has also helped push sales up for many Chinese hoteliers, including Home Inns & Hotels.
But early this year, Home Inns got a nasty surprise. In March, the company announced that it had earned less than half what Wall Street had expected, despite giving full-year 2012 revenue guidance that exceeded analyst expectations. China Lodging Group (Nasdaq: HTHT ) had similarly bad results, although 7 Days (Nasdaq: SVN ) managed to provide an earnings beat.
Since then, though, things have gotten a bit better. Last month, Home Inns managed to beat earnings-per-share estimates. But concerns about the Chinese economy led it to temper its forward guidance somewhat, with its recent acquisition of the Hotel 168 chain leaving it more exposed to a slowdown in the Yangtze Delta region.
For Home Inns to improve, it needs to get its margins back up and stop its balance sheet from getting less healthy. If recent measures to stimulate the Chinese economy work, then Home Inns could be a prime beneficiary.
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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