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 Portfolio Recovery Associates (NAS: PRAA) 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 Portfolio Recovery Associates.
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%
8 out of 10
Source: S&P Capital IQ. Total score = number of passes.
With eight points, Portfolio Recovery Associates lacks only the dividend that investors like to see in a perfect stock. The company has an unusual business model that it has used highly effectively, yet shareholders haven't seen huge benefits recently from its success.
Collecting bad debts may not sound like the sort of business that you'd expect to see trading on a major exchange. But Portfolio Recovery serves the useful purpose of helping its customers with collections so that they don't have to worry about them -- and manages to make profits from them.
Debt collection, however, is a competitive business, with a number of companies bidding for the most promising collection opportunities. Encore Capital (NAS: ECPG) works in roughly the same areas as Portfolio Recovery, while EPIQ Systems (NAS: EPIQ) specializes in bankruptcy claim streamlining and other legal recovery work. Yet Portfolio Recovery boasts by far the best net margins of the group, showing the attention to detail that CEO Stephen Fredrickson aspires to.
One challenge ahead could come from the Consumer Financial Protection Bureau. Along with overseeing credit bureaus Equifax (NYS: EFX) and Fair Isaac (NYS: FICO) , the CFPB will look over debt collection efforts as well. Yet that could actually give Portfolio Recovery an advantage over its competition by giving it a chance to benefit from superior practices.
Earlier this week, Portfolio Recovery announced a strong first quarter. With cash collection rising 31% and profits enjoying a 10% rise, the company came in well ahead of Wall Street expectations. In particular, its legal collections business contributed greatly to net income.
For Portfolio Recovery to keep improving, all it needs is to start paying a dividend. As long as it keeps chugging along, it's pretty much up to company management to decide when Portfolio Recovery could become a perfect stock.
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 Portfolio Recovery Associates. Motley Fool newsletter services have recommended buying shares of EPIQ Systems and Portfolio Recovery Associates, as well as writing puts on Portfolio Recovery Associates. 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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