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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 whether Pengrowth Energy (NYSE: PGH ) 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 that 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 Pengrowth Energy.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||11.5%||fail|
|1-Year Revenue Growth > 12%||0.1%||fail|
|Margins||Gross Margin > 35%||80.3%||pass|
|Net Margin > 15%||13.5%||fail|
|Balance Sheet||Debt to Equity < 50%||0.6%||pass|
|Current Ratio > 1.3||2.03||pass|
|Opportunities||Return on Equity > 15%||15.4%||pass|
|Valuation||Normalized P/E < 20||14.36||pass|
|Dividends||Current Yield > 2%||6.2%||pass|
|5-Year Dividend Growth > 10%||9.6%||fail|
|Total Score||6 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of 6, Pengrowth Energy scores pretty well. Moreover, several of the areas where it falls short, such as dividend growth and net margins, are near misses, suggesting that even slightly improved conditions could add a couple extra points.
Like fellow Canadian royalty trusts Penn West Energy (NYSE: PWE ) and Enerplus Resources (NYSE: ERF ) , Pengrowth has had to face the end of a favored tax status that will require it to convert to a corporation at the end of the year. Yet while some royalty trusts may face lower dividends as a result, Pengrowth's large tax losses may help it maintain its current healthy payout.
In terms of revenue, weak natural gas prices have put a big damper on Pengrowth's growth in recent years. But given rising interest in mergers and joint ventures in the space -- Chesapeake Energy (NYSE: CHK ) recently entered an agreement with China's CNOOC (NYSE: CEO ) to develop energy in the South Texas Eagle Ford shale gas area -- low valuations and attractive cash flows raise the possibility of Pengrowth and its peers being takeover candidates. Whether it gets bought out or continues as an independent company, though, the future looks promising for Pengrowth.
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.
Want to own the perfect stock? Click here to read our special report, 5 Stocks the Motley Fool Owns -- And You Should Too.