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 Chimera (NYSE:CIM) 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.
Why perfection has eluded Chimera
Unfortunately, because nearly all of Chimera's financial information is woefully out of date, it's impossible to evaluate the mortgage REIT on most of those factors. Just about the only thing we know for sure is that Chimera pays a dividend yield of 11.3% but has seen its quarterly payout shrink dramatically from its 2008 levels. That's fairly consistent with what we saw from Chimera last year. Moreover, the share price has gone up by 6%, which, in addition to the dividend that investors have pocketed over the interim, adds up to a healthy total return.
The main problem in evaluating Chimera is that it's more than a year behind in filing its required reports with the SEC. The company just managed to file its 2011 annual report earlier this month, reporting a GAAP book value of $2.97 per share. Since then, the only thing Chimera has reported is an estimate of book value, which had risen to $3.42 per share as of the end of 2012.
Of course, it's easy to use what's happening with other mortgage REITs as a proxy for what's going on behind the scene at Chimera. The Federal Reserve's use of mortgage-backed securities as part of its quantitative easing program has made it tougher for Annaly Capital (NYSE:NLY) and ARMOUR Residential (NYSE:ARR) to get good deals on scarcer agency-backed loans, leading to share-price declines and dividend reductions. Yet rival American Capital Agency (NASDAQ:AGNC) has been able to buck the trend, keeping its share price moving higher as well as sustaining its dividend.
However, since Chimera specializes in non-agency-backed mortgage securities, that comparison only goes so far. Complicated accounting rules apply to non-agency paper, and those rules were at the center of the delays of the REIT's 2011 filing, which included downward restatements to previously reported net income. Yet investors seem comfortable with the implications of those restatements and have retained confidence in Chimera.
Still, for Chimera to improve, it needs to provide reliable financial information on a timely basis. Only then can investors fully evaluate on a rational basis whether the REIT has the attributes investors want from a strong and healthy stock.
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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Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.