Has Linn Energy Become the Perfect Stock?

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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 Linn Energy (NAS: LINE) 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 Linn Energy.

Factor

What We Want to See

Actual

Pass or Fail?

Growth5-Year Annual Revenue Growth > 15%69.5%Pass
 1-Year Revenue Growth > 12%72.4%Pass
MarginsGross Margin > 35%77%Pass
 Net Margin > 15%(47.8%)Fail
Balance SheetDebt to Equity < 50%101.8%Fail
 Current Ratio > 1.31.39Pass
OpportunitiesReturn on Equity > 15%(15.4%)Fail
ValuationNormalized P/E < 20NMNM
DividendsCurrent Yield > 2%7.6%Pass
 5-Year Dividend Growth > 10%30%Pass
    
 Total Score 6 out of 9

Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful due to negative earnings. Total score = number of passes.

When we looked at Linn Energy last year, it had a score of 5, so the company has gotten a point closer to perfection. It is still seeing net losses, and net margins actually got worse in the past year despite strong revenue growth. But there's more to the story than those numbers suggest.

Linn Energy was one of the darlings of the recovery after the market meltdown in early 2009. Investors essentially left the oil and gas exploration company for dead during the worst of the credit crunch, but once Linn secured long-term pricing, they gained more confidence in the company's future prospects.

More recently, though, the company has struggled. Linn has missed analyst estimates in three of the four past quarters, including a big 23% shortfall last quarter. That's very similar to the experiences of Kinder Morgan Energy Partners (NYS: KMP) and Energy Transfer Partners (NYS: ETP) , although Enterprise Products Partners (NYS: EPD) has bucked the trend and posted a strong earnings surprise last quarter. Moreover, because Linn is less insulated from energy price movements than pipeline companies like Kinder Morgan and Enterprise Products, it stands to suffer even more from the drop in oil prices over the past several months.

It's important to understand that with master limited partnerships like Linn Energy, GAAP earnings and margins figures don't always tell the complete story. For many, the stock's extremely attractive dividend yield, which falls short of peers like Cheniere Energy (ASE: CQP) and Inergy (NYS: NRGY) but still comes in well above 7%, speaks for itself. Unless oil prices rebound from their recent sell-off, though, Linn Energy won't reach perfection.

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.

Click here to add Linn Energy to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."

At the time this article was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. Motley Fool newsletter services have recommended buying shares of Enterprise Products Partners. 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 Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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