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 KB Home 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 KB Home.
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%
2 out of 9
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
Since we looked at KB Home last year, the company hasn't been able to add to its two-point performance. But the stock has absolutely exploded higher, soaring more than 60% in the past year as the housing rebound has started to take shape.
Homebuilder stocks have spent much of the past several years in repeated attempts to pick themselves up off the floor, only to be thwarted by renewed pressures in the housing market. Finally, though, 2012 gave homebuilders the rebound they'd been looking for, with Hovnanian seeing its shares rise fourfold on a big rise in order activity.
With investors piling into the space, KB Home has been able to take advantage of favorable conditions to raise capital. Less than a month ago, it raised more than $330 million selling common stock and convertible notes without any adverse impact on the share price, which under ordinary circumstances would be expected from a potentially dilutive offering.
Yet it's important to recognize that KB Home has a long way to go. Rivals PulteGroup and Toll Brothers have rebounded from past losses to return to profitability, giving their own share-price advances some fundamental backing. Yet even with two straight quarters of positive net income, KB Home still posted a loss for 2012.
For KB Home to justify its recent share-price spike, it needs to keep revenue moving in the right direction and work on higher-margin sales that can help put it back in the black. If it succeeds, then KB Home will need the economy to cooperate in order to give it the long-term support that could push it toward perfection.
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.
No matter what industry you like, the best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.
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The article Has KB Home Become the Perfect Stock? originally appeared on Fool.com.
Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.
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