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 Armour Residential (NYSE: ARR) 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 Armour Residential.


What We Want to See


Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 66.9%* Pass
  1-Year Revenue Growth > 12% 1776.6% Pass
Margins Gross Margin > 35% 97.6% Pass
  Net Margin > 15% 85% Pass
Balance Sheet Debt to Equity < 50% 953.7% Fail
  Current Ratio > 1.3 0.03 Fail
Opportunities Return on Equity > 15% 12.3% Fail
Valuation Normalized P/E < 20 9.84 Pass
Dividends Current Yield > 2% 18.9% Pass
  5-Year Dividend Growth > 10% NM NM
  Total Score   6 out of 9

Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful. *3 1/4 year growth rate. Total score = number of passes. Armour started paying a dividend in March 2010. 

With a score of 6, Armour does a pretty good job of putting a roof over investors' heads. The REIT has a super-high yield, but with plenty of leverage to go with it, Armour isn't risk-free by any means.

It wasn't so long ago that most investors wouldn't have had a clue what a mortgage REIT was. But with record-low interest rates, mortgage REITs have moved front and center of the investing world, as their high yields have attracted plenty of attention. Like fellow REITs Annaly Capital (NYSE: NLY) and Chimera Investment (NYSE: CIM), Armour invests in mortgage-backed securities, borrowing at short-term rates and collecting income at higher long-term rates. Like Annaly, Armour focuses on government agency mortgage debt, rather than the non-government mortgage-backed securities that make up much of Chimera's portfolio.

What makes mortgage REITs risky is leverage, and that's something Armour has a lot of. With $9.50 in debt for every $1 of shareholder equity, Armour's leverage exceeds Annaly and Chimera by a wide margin, as well as fellow REITs Resource Capital (NYSE: RSO) and American Capital Agency (Nasdaq: AGNC).

As long as low rates persist, Armour may well make enough income to support its yield of almost 20%. But when rate spreads start to tighten, you should expect to see the stock's dividends fall -- perhaps sharply. That may be a risk you're willing to take, but it shows how high-yielding mortgage REITs like Armour aren't perfect.

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.

Click here to add Armour Residential to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

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.

Fool contributor Dan Caplinger owns shares of Chimera. The Motley Fool owns shares of Chimera and 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.