Has InterOil 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 InterOil (NYS: IOC) 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 InterOil.

Factor

What We Want to See

Actual

Pass or Fail?

Growth5-Year Annual Revenue Growth > 15%14.3%Fail
 1-Year Revenue Growth > 12%20.7%Pass
MarginsGross Margin > 35%13.1%Fail
 Net Margin > 15%(2.7%)Fail
Balance SheetDebt to Equity < 50%26.9%Pass
 Current Ratio > 1.32.54Pass
OpportunitiesReturn on Equity > 15%(4.4%)Fail
ValuationNormalized P/E < 20120.26Fail
DividendsCurrent Yield > 2%0%Fail
 5-Year Dividend Growth > 10%0%Fail
    
 Total Score 3 out of 10

Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.

When we looked at InterOil last year, it weighed in with exactly the same score of 3. Despite some decent revenue growth in the past year, the stock has dropped sharply and remains quite a distance from perfection.

The natural gas story remains largely unchanged from where it was a year ago. Prices remain low compared to oil, but with limited infrastructure in place, it's a lot harder to transport natural gas around the world than crude. ConocoPhillips (NYS: COP) and partner Marathon Oil (NYS: MRO) operate a liquefied natural gas export plant in Alaska, but the company plans to shut it down. Cheniere Energy (NYS: LNG) is the general partner on an LNG terminal in the Sabine Pass region of Louisiana and plans to add a liquefaction plant to import and export LNG.

Along those lines, InterOil has gotten a lot of investor interest, especially due to a big investment from hedge fund giant George Soros. The company has planned an LNG project in Papua New Guinea, which gives it access to the hungry energy markets of Asia. But last week, the country's energy minister suggested that InterOil might need to make major changes to the project, causing shares to plummet. With the government seeking a larger facility than InterOil planned, the company could have trouble getting financing.

Obviously, InterOil is at a critical juncture right now. If it can make the Papua New Guinea government happy, then shares could recover much of their losses. If not, though, the losses that InterOil has seen could be the tip of the iceberg, and shareholders may never find themselves owning the perfect stock.

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 InterOil 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. 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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