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 China Automotive Systems
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 China Automotive Systems.
|
Factor |
What We Want to See |
Actual |
Pass or Fail? |
|---|---|---|---|
| Growth | 5-Year Annual Revenue Growth > 15% | 39.0% | Pass |
| 1-Year Revenue Growth > 12% | 56.7% | Pass | |
| Margins | Gross Margin > 35% | 27.3% | Fail |
| Net Margin > 15% | 10.2% | Fail | |
| Balance Sheet | Debt to Equity < 50% | 56.4% | Fail |
| Current Ratio > 1.3 | 1.39 | Pass | |
| Opportunities | Return on Equity > 15% | 29.8% | Pass |
| Valuation | Normalized P/E < 20 | 7.05 | Pass |
| Dividends | Current Yield > 2% | 0.0% | Fail |
| 5-Year Dividend Growth > 10% | 0.0% | Fail | |
| Total Score | 5 out of 10 |
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With five points, China Automotive Systems falls right in the middle of our range. The company was already facing headwinds even before the latest scandals hitting Chinese small-cap stocks started to hit.
China Automotive makes components for auto manufacturers. Last year, Global Gains analyst Tim Hanson took a close look at how the Chinese manufacturing industry was extremely vulnerable to pressure on China to let its currency strengthen, which would remove much of the cost advantage that Chinese manufacturers like China XD Plastics
But recently, investors are scared to death of small publicly traded Chinese companies. Long trading halts stemming from fraud allegations for companies like Longtop Financial
Fundamentals, though, continue to look strong. In its most recent quarter, the company saw operating income more than double, while revenue was well above analyst estimates. More importantly for nervous investors, the company said it was making progress on restating its past financials to make necessary adjustments, and expects 20% revenue growth this year. Yet now, the company faces a delisting notice for failing to file its quarterly report on time.
Things for China Automotive are anything but perfect right now -- unless you're a deep-value investor with complete confidence in the company's integrity and financial results. The company hasn't made it easy to feel that way, but in the long run, China Automotive may well prove its supporters right.
Keep searching
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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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."
