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 Moody's (MCO 1.58%) 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 Moody's.
Factor |
What We Want to See |
Actual |
Pass or Fail? |
---|---|---|---|
Growth |
5-Year Annual Revenue Growth > 15% |
1.6% |
Fail |
1-Year Revenue Growth > 12% |
11.6% |
Fail |
|
Margins |
Gross Margin > 35% |
70.3% |
Pass |
Net Margin > 15% |
24.6% |
Pass |
|
Balance Sheet |
Debt to Equity < 50% |
436.4% |
Fail |
Current Ratio > 1.3 |
2.24 |
Pass |
|
Opportunities |
Return on Equity > 15% |
585.7% |
Pass |
Valuation |
Normalized P/E < 20 |
17.80 |
Pass |
Dividends |
Current Yield > 2% |
1.4% |
Fail |
5-Year Dividend Growth > 10% |
14.9% |
Pass |
|
Total Score |
6 out of 10 |
Since we looked at Moody's last year, the company has held onto its six-point score. But the stock has done quite well, rising about 35% over the past year.
Moody's plays a key role in the financial markets, providing ratings that many institutions rely on to make investment decisions. Yet that's exactly what has gotten Moody's and peers Fitch Ratings and McGraw-Hill's (SPGI 0.93%) Standard & Poor's into trouble, as glowing ratings on Bank of America (BAC 1.90%), Citigroup, and many other top banks prior to the financial crisis proved to be overly optimistic. Despite the subsequent fallout, the industry has largely failed to make significant changes.
As a result, the influence that Moody's and other ratings agencies have over the markets has waned, at least among mainstream investors. Earlier this year, for instance, the company considered downgrading a host of banks. But as Fool analyst Matt Koppenheffer noted, the call seemed far too late to make any appreciable difference.
Nevertheless, the healthy credit markets are still bringing in plenty of business for Moody's. With bond issuance at record levels, more issuers need ratings, and Moody's gets its fair share of business from providing those ratings. That's a big part of why Berkshire Hathaway (BRK.B 0.24%) owns the stock, and some believe Warren Buffett may add to his position in Moody's or even make a full acquisition.
For Moody's to improve, continued dividend increases would go a long way toward making the stock more attractive. Combine that with further revenue gains, and the path to perfection for Moody's, though difficult, is pretty clear.
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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