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 SandRidge Energy (NYS: SD) 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 SandRidge Energy.
What We Want to See
Pass or Fail?
5-Year Annual Revenue Growth > 15%
1-Year Revenue Growth > 12%
Gross Margin > 35%
Net Margin > 15%
Debt to Equity < 50%
Current Ratio > 1.3
Return on Equity > 15%
Normalized P/E < 20
Current Yield > 2%
5-Year Dividend Growth > 10%
3 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 SandRidge Energy last year, it had a score of 2, so the company has made a small improvement since then. But despite strong revenue growth in the past year, the oil company still carries high debt, lacks a dividend, and could see future trouble as oil prices have started to decline.
SandRidge originally started out as a natural gas company, as CEO Tom Ward was a co-founder of Chesapeake Energy (NYS: CHK) before founding SandRidge in 2006. But since the natural gas environment has been ugly for years, SandRidge moved its focus toward oil drilling and is now the third-largest operator of oil rigs behind Chesapeake and EOG Resources (NYS: EOG) .
SandRidge isn't pulling any punches when it comes to investing in energy. The company has spent billions on capital expenditures to drill its properties, which has outpaced its cash flow. SandRidge has financed that spending in part by spinning off two royalty trusts: SandRidge Mississippian Trust (NYS: SDT) and SandRidge Permian Trust (NYS: PER) .
SandRidge shares have plummeted in recent months, leaving the stock far short of perfection in current shareholders' eyes. Given its big bets, SandRidge is a risky way to play the sector, but a rebound in energy prices could send the shares soaring again.
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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At the time thisarticle was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy. 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.
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