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 Transocean.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||29.4%||Pass|
| ||1-Year Revenue Growth > 12%||(16.1%)||Fail|
|Margins||Gross Margin > 35%||50.1%||Pass|
| ||Net Margin > 15%||24.5%||Pass|
|Balance Sheet||Debt to Equity < 50%||61.1%||Fail|
| ||Current Ratio > 1.3||1.63||Pass|
|Opportunities||Return on Equity > 15%||12.2%||Fail|
|Valuation||Normalized P/E < 20||12.69||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
| ||5-Year Dividend Growth > 10%||0%||Fail|
| || || || |
| ||Total Score|| ||5 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Transocean weighs in with a score of 5. That's not perfect, but in the aftermath of the Gulf oil spill, it's a whole lot better than what many might have foreseen for the offshore driller.
Looking just at the fundamentals of the oil industry, you'd think Transocean would be on top of the world right now. Oil prices have been on the rise throughout much of the past two years, currently hovering at the $90 level.
But the BP (NYSE: BP) disaster, and regulatory headaches thanks to the drilling moratorium that followed, made things a lot tougher for Transocean. As of November, fully half of the company's jackup fleet had stopped working. That puts it at a competitive disadvantage to competitors Seadrill (Nasdaq: SDRL) and Rowan Companies (NYSE: RDC), both of which already have "high-spec" jackups that can handle tougher work than standard jackups.
In addition, liability concerns still plague the company. Last week, the government sued BP, Transocean, and several other companies for environmental law violations related to the spill -- though interestingly, Halliburton (NYSE: HAL), which handled the contract work to cement the Gulf well, wasn't among the companies sued. With the potential for unlimited liability for the spill, the financial dust will inevitably take a lot longer to settle out than investors would like, weighing on Transocean shares for months or even possibly years.
Despite the uncertainty, shares have recovered a lot of ground since the spill, as investors recognize the longer-term strength of the company. Transocean may not be the perfect stock now, but if the energy business continues to enjoy high oil prices, demand for drilling should help bolster the company's prospects.
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.
© 2010 UCLICK L.L.C.