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 Raytheon (NYSE: RTN ) 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 Raytheon.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||4.8%||Fail|
|1-Year Revenue Growth > 12%||(1.3%)||Fail|
|Margins||Gross Margin > 35%||20.8%||Fail|
|Net Margin > 15%||7.5%||Fail|
|Balance Sheet||Debt to Equity < 50%||55.2%||Fail|
|Current Ratio > 1.3||1.52||Pass|
|Opportunities||Return on Equity > 15%||20.8%||Pass|
|Valuation||Normalized P/E < 20||10.49||Pass|
|Dividends||Current Yield > 2%||3.4%||Pass|
|5-Year Dividend Growth > 10%||12.4%||Pass|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Raytheon last year, the defense contractor has lost a point. Higher debt is responsible for the slight move down, but a bigger threat could lie ahead for the company.
Defense cuts are already taking their toll on the industry. Both Harris (NYSE: HRS ) and L-3 Communications (NYSE: LLL ) recently reported earnings that beat estimates, but Harris guided its expected 2012 revenue figures downward, and L-3 cited a "challenging defense budget environment" in reporting sales for the fourth quarter that fell well short of expectations. Raytheon reported a 6% drop in sales for its fourth quarter even as net income leaped 34%.
But Raytheon is trying to tap into trends that will benefit from budget cuts. The company is working with Alliant Techsystems (NYSE: ATK ) to develop tiny guided bomblets weighing less than 25 pounds for use with unmanned aerial vehicles. The cost savings involved could push more business Raytheon's way if the venture is successful.
Still, the withdrawals from Iraq and Afghanistan have dramatically changed the landscape for government contractors. Ford (NYSE: F ) even passed on a requested bid for the joint light tactical vehicle project when the government asked it to partner with Raytheon to build a better vehicle. When projects are apt to have their funding cut at a moment's notice, it gets less lucrative to bid on them.
Raytheon's shares are cheap, reflecting the uncertainty. But to move toward perfection, Raytheon needs to find the niche of surviving defense contracts and milk it for all it's worth. If it can, then Raytheon could be the winner in a challenged industry.
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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