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 Anworth Mortgage (NYS: ANH) 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 Anworth Mortgage.
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%
5 out of 9
Source: S&P Capital IQ. NM = not meaningful; Anworth had negative net revenue five years ago. Total score = number of passes.
Since we looked at Anworth Mortgage last year, the mortgage REIT has kept the same score. The company continues to benefit from a favorable interest rate environment, but investors still worry about when the good times may end.
Like other popular mortgage REITs such as Annaly Capital (NYS: NLY) and American Capital Agency (NAS: AGNC) , Anworth has made huge profits in recent years from the big spreads between the short-term rates it has to pay to borrow capital and the long-term rates it earns on the mortgage securities it owns. Those spreads have produced the double-digit percentage yields that Anworth and several of its peers enjoy.
But for a while now, investors have feared a shift. Last month, Anworth's stock fell more than 11% after the company announced a reduction of $0.02 in its quarterly dividend. Yet the shares regained nearly all of that lost ground after Anworth said it would do a large repurchase of shares.
Moreover, Anworth has substantially greater leverage than many of its fellow mortgage REITs. ARMOUR Residential (NYS: ARR) , Capstead Mortgage (NYS: CMO) , and American Capital Agency are among the only mortgage REITs that take on more leverage. With some proposals on the table to curb the ability of mortgage REITs to use extreme borrowing to boost their returns, the whole industry's business model is at risk.
It's hard to imagine how interest rates could go much lower, and so it seems like Anworth is at the peak of its cycle. But even if the company can't score any better on its strong dividends, shareholders should be happy if the current yield persists for another couple of years -- even if the stock's price goes nowhere.
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. The Motley Fool owns shares of Annaly Capital Management. 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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