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 Northrop Grumman (NYS: NOC) 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 Northrop Grumman.
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 10
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Northrop Grumman last year, the stock has kept its five-point score. Falling revenue shows the impact of defense cuts, which could get even more dramatic in the years ahead.
In the budget-cutting game going on at the Pentagon, companies across the defense industry are positioning themselves to try to explain why their projects are better than those of their competitors. For instance, Northrop was fighting against Boeing (NYS: BA) and Lockheed Martin (NYS: LMT) to pick up an unmanned aerial vehicle contract for maritime purposes. When the Defense Department decided to eliminate the project, part of the justification was that Northrop's existing drone was adequate to the task. In fact, the move actually boosts Northrop's prospects, as an upgrade to its Fire Scout will make its planned sales more secure against future cuts. Textron (NYS: TXT) , which will supply the new chassis for the upgrade, will also benefit.
But slashes to the defense budget will still hit Northrop. In a recent round of cuts, the company's Global Hawk spy drone project got eliminated, giving competitor Lockheed Martin's U-2 spy planes a longer lifespan than some had anticipated.
Still, unmanned vehicles seem to be where the action is, and Northrop has the inside track there. United Technologies (NYS: UTX) wants to get into the unmanned game by adapting its helicopter fleet to the purpose, but Northrop will be hard to unseat in the space.
Eventually, budget cuts will end, and Northrop will be in a position to start thinking about growth again. When that happens, the path to perfection will simply require beating its competitors to the starting line and making the most of the opportunity.
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 in this article. The Motley Fool owns shares of Lockheed Martin, Northrop Grumman, and Textron. 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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