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 Dynegy (NYS: DYN) 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 Dynegy.
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%
1 out of 9
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
Dynegy only charges up its score for one point. That's a tough spot for a utility company to find itself in, given that shareholders generally expect utilities to deliver solid dividends with reasonable if unexciting profits.
Dynegy's business, however, doesn't resemble traditional utilities like Duke Energy (NYS: DUK) and Southern (NYS: SO) . During the era of deregulation, some utilities chose to focus solely on either transmission and distribution or on power generation. Dynegy chose production, and as a result, Dynegy and its competitors, which include NRG Energy (NYS: NRG) and Calpine (NYS: CPN) , have to sell power on the open market to a variety of transmission-focused customers, leaving them exposed to market forces.
Dynegy's woes have brought it to the forefront of potential M&A activity. Last year, Blackstone (NYS: BX) offered to buy the company for $5 per share, but management turned down the offer. Then, Icahn Enterprises (NYS: IEP) made a higher offer of $5.50 per share, but billionaire Carl Icahn couldn't get enough shareholders to agree to the deal.
Unfortunately, some analysts think that Dynegy won't survive. GovernanceMetrics International pegged the company's financial distress probability at 10.6%, and the fact that bondholders have sued the company after its restructuring to avoid bankruptcy bodes ill for Dynegy's future prospects.
If Dynegy does come back, it could prove a windfall for stubborn shareholders. But at the moment, it doesn't look likely that Dynegy will become a perfect stock anytime soon.
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 the best investments from the rest.
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At the time thisarticle was published
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