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 if American Capital Agency
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 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 American Capital Agency.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-year annual revenue growth > 15%||108.9%*||Pass|
|1-year revenue growth > 12%||136.3%||Pass|
|Margins||Gross margin > 35%||100%||Pass|
|Net margin > 15%||93.7%||Pass|
|Balance sheet||Debt to equity < 50%||763.2%||Fail|
|Current ratio > 1.3||0.08||Fail|
|Opportunities||Return on equity > 15%||27.2%||Pass|
|Valuation||Normalized P/E < 20||6.95||Pass|
|Dividends||Current yield > 2%||19.1%||Pass|
|5-year dividend growth > 10%||14.1%*||Pass|
|Total Score||8 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes. *Two-year growth rates.
American Capital Agency comes pretty close to perfection, scoring a strong eight points. This new company arrived at a perfect moment, finding itself in the middle of a boom time for its industry.
American Capital Agency is a mortgage real estate investment trust that uses leverage to invest in mortgage-backed securities. By borrowing short-term money and investing it in longer-term mortgage securities, the REIT aims to capture the difference in profits. That's been a highly successful business model , whether you focus on agency-issued mortgage securities as Annaly Capital
Even among mortgage REITs, American Capital Agency tops the list with the highest yield, beating out Annaly and Chimera as well as peers Invesco Mortgage Capital
American Capital Agency has the growth and dividend combination that makes it look almost perfect. But mortgage REITs are cyclical, and the perfect conditions that have produced such stellar profits could go away at anytime. As long as you understand that risk, though, American Capital Agency might be the perfect stock for you.
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 owns shares of Chimera Investment. The Fool owns 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.