Has Valero Become the Perfect Stock?

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 Valero (VLO -0.05%) 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 Valero.

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Valero last year, the company kept both of the points it earned from 2010 to 2011. The stock has also done well, posting a 15% gain over the past year even as many energy companies have seen falling prices.

In general, refinery companies have had a nice year. The boom in energy production in the U.S. has sent prices of West Texas Intermediate crude sharply lower compared to much more expensive Brent European oil, and that has benefited refiners that get most of their oil from areas that produce West Texas Intermediate. That's been extremely lucrative for HollyFrontier (HFC) and Marathon Petroleum (MPC 0.34%), both of which fall into that category. Unfortunately, Valero gets much of its feedstock from Light Louisiana Sweet crude, which carries higher prices.

In recent weeks, though, gasoline prices are starting to follow oil prices lower. That in turn has sent shares of Valero and its peers sharply lower, as margins could start to compress and leave refiners without the profits they've grown accustomed to.

In addition, Valero faces a threat from potential regulation against hydraulic fracturing in California. A lawsuit there could knock out production from Valero as well as Phillips 66 (PSX -0.32%), BP (BP 0.71%), and HollyFrontier, among several others.

Despite having room to earn a better score, Valero will struggle to try to get much closer to perfection. Refining is a business where it's hard to boost margins, and boosting returns on equity would likely require the offsetting need to increase debt. At current valuations, investors expect Valero's recent financial performance to disappear, and that makes it a tough call to anticipate perfection for Valero.

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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