Tue, 23/11/2010 - 11:15 by Dan Caplinger
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 whether ConocoPhillips (NYSE: COP) 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 ConocoPhillips.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||2.1%||fail|
| ||1-Year Revenue Growth > 12%||21%||pass|
|Margins||Gross Margin > 35%||25.3%||fail|
| ||Net Margin > 15%||6.6%||fail|
|Balance Sheet||Debt to Equity < 50%||41.5%||pass|
| ||Current Ratio > 1.3||1.39||pass|
|Opportunities||Return on Equity > 15%||16.9%||pass|
|Valuation||Normalized P/E < 20||11.45||pass|
|Dividends||Current Yield > 2%||3.6%||pass|
| ||5-Year Dividend Growth > 10%||13.5%||pass|
| || || || |
| ||Total Score|| ||7 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of 7, ConocoPhillips comes reasonably close to perfection. Given that margins never got close to our target levels even when oil spiked to $147 a barrel, it's not terribly likely that the oil giant will improve on its score.
ConocoPhillips is using an interesting strategy that sets it apart from its major rivals.ExxonMobil (NYSE: XOM) completed its merger with gas giant XTO Energy earlier this year, while Chevron (NYSE: CVX) is entering the M&A arena with a bid for Atlas Energy (Nasdaq:ATLS).
But instead of seeking major acquisitions, ConocoPhillips has joined Shell (NYSE: RDS-A)and BP (NYSE: BP) in divesting itself of assets. The company has sold part of its major stake in Russia's Lukoil as well as its share of Canada's Syncrude oil sands venture to Sinopec Group (NYSE: SNP).
With a healthy dividend that has grown over time and a reasonable valuation, ConocoPhillips looks fairly attractive right now. If you're willing to accept the commodity-market risks that all oil companies share, then while ConocoPhillips may not be perfect, you could find worse places to put your money.
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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