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 Cliffs Natural Resources
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 Cliffs Natural Resources.
|
Factor |
What We Want to See |
Actual |
Pass or Fail? |
|---|---|---|---|
| Growth | 5-Year Annual Revenue Growth > 15% | 27.3% | Pass |
| 1-Year Revenue Growth > 12% | 16.3% | Pass | |
| Margins | Gross Margin > 35% | 32.5% | Fail |
| Net Margin > 15% | 21.2% | Pass | |
| Balance Sheet | Debt to Equity < 50% | 56.4% | Fail |
| Current Ratio > 1.3 | 1.14 | Fail | |
| Opportunities | Return on Equity > 15% | 23.3% | Pass |
| Valuation | Normalized P/E < 20 | 5.33 | Pass |
| Dividends | Current Yield > 2% | 6.5% | Pass |
| 5-Year Dividend Growth > 10% | 42.4% | Pass | |
| Total Score | 7 out of 10 |
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Cliffs Natural Resources last year, the company has seen its score drop by two points, more than reversing its one-point gain from 2010 to 2011. The stock has plunged in the past six months, with investors suffering about a 20% drop over the past year.
Cliffs is involved in digging up two major resources, and neither one is doing all that well. Thermal coal has been in a dismal slump due to competition from natural gas, which has gotten cheap enough that electric utilities have been switching from coal to gas for fuel to generate electricity. That helped send Patriot Coal to a bankruptcy filing and has crushed shares of Peabody Energy
At the same time, iron ore and metallurgical coal demand has also fallen, mostly due to a slowdown in Chinese growth. Vale
Admittedly, Cliffs could benefit from the recent move from the Chinese government to inject $150 billion in stimulus money into the Chinese economy, with a focus on infrastructure projects. But the money is just a short-term boost for a problem that could persist for quite a while.
For Cliffs to get back toward perfection, it needs the global economy to get moving in the right direction again. If it gets that fortunate break, then Cliffs could reverse its score losses and bring shareholders right to where they want to be.
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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