Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?
One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if General Dynamics (NYSE: GD) fits the bill.
The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.
Some of the most basic yet important things to look for in a stock are:
- 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 don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
- Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
- Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
- Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. 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 General Dynamics.
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Growth | 5-year annual revenue growth > 15% | 9.8% | fail |
| 1-year revenue growth > 12% | 0.4% | fail | |
| Margins | Gross margin > 35% | 17.9% | fail |
| Net margin > 15% | 7.7% | fail | |
| Balance Sheet | Debt to equity < 50% | 30.1% | pass |
| Current ratio > 1.3 | 1.34 | pass | |
| Opportunities | Return on equity > 15% | 20.5% | pass |
| Valuation | Normalized P/E < 20 | 11.17 | pass |
| Dividends | Current yield > 2% | 2.7% | pass |
| 5-year dividend growth > 10% | 16.1% | pass | |
| Total Score | 6 out of 10 |
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of six, General Dynamics puts in a good performance. Although it hasn't seen much growth lately, the company is in good financial shape and offers appealing value even as the overall stock market has risen over the past year and a half.
As a major defense contractor, General Dynamics is vulnerable to the whims of the federal government's spending practices. Last month, the company announced that unless the Pentagon funded its Autonomous Navigation System project, it would have to lay off more than 100 workers.
But General Dynamics is in a stronger position to weather adversity than its peers. Competitor Boeing (NYSE: BA) has a higher levels of debt, and Lockheed Martin (NYSE: LMT) recently disappointed with earnings. Also, after seeing its F-22 program die on the Pentagon chopping block, Lockheed is extremely reliant on strong F-35 support in the coming decades.
The greater threat, though, may come from below. Small competitors such as iRobot (Nasdaq: IRBT) and Force Protection (Nasdaq: FRPT), who can nimbly offer innovative products in niche areas, may have the upper hand in grabbing business from an increasingly cost-conscious defense industry. Meanwhile, as the maker of Gulfstream private jets, General Dynamics has seen increased competition from Brazil's Embraer (NYSE: ERJ).
Despite federal budget pressures, defense spending isn't going away anytime soon, and General Dynamics is still poised to benefit from that. Long term, though, adding geographical diversity to its U.S.-centered business may be the key to reigniting growth.
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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