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 American Capital Agency
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 American Capital Agency.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||129.4%*||Pass|
|1-Year Revenue Growth > 12%||176.7%||Pass|
|Margins||Gross Margin > 35%||100%||Pass|
|Net Margin > 15%||90.6%||Pass|
|Balance Sheet||Debt to Equity < 50%||796.7%||Fail|
|Current Ratio > 1.3||0.06||Fail|
|Opportunities||Return on Equity > 15%||19.8%||Pass|
|Valuation||Normalized P/E < 20||9.66||Pass|
|Dividends||Current Yield > 2%||16.4%||Pass|
|5-Year Dividend Growth > 10%||9.2%*||Fail|
|Total Score||7 out of 10|
Source: S&P Capital IQ. Total score = number of passes. *Three-year growth rates.
Since we looked at American Capital Agency last year, the mortgage REIT has dropped a point. Dividend growth has slowed and recently even reversed course, which could be a sign of things to come for the company.
Investors have gravitated to mortgage REITs for their outsized dividends. With bonds yielding next to nothing, the double-digit yields that American Capital Agency and its peers offer look exceptionally attractive.
But recently, changing trends are threatening those dividends. In its most recent quarter, American Capital Agency reported lower earnings per share due to a big jump in outstanding shares, and more importantly cut its dividend from $1.40 per share to $1.25 for the first quarter of 2012. The company's interest rate spread fell below 2%, prompting further concerns.
The challenges aren't unique to American Capital Agency. Annaly Capital
Given its leverage, American Capital Agency is as close to perfection as it's likely going to get. If conditions continue to worsen, though, the company could deteriorate further in the years ahead.
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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Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Chimera Investment and Annaly Capital. Motley Fool newsletter services have recommended buying shares of Annaly Capital. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.
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