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 AK Steel (NYS: AKS) 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 AK Steel.
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. *Four-year growth rate.
Since we looked at AK Steel last year, the company has kept its two-point score. The stock, though, has plunged as concerns about the future of the global economy have hit the steel industry hard.
As goes China, so goes the steel industry, and lately that's been a hard road to follow. Back in March, one measure of manufacturing activity in China started signaling a contraction, which led to big drops in stocks throughout the sector. At the time, Nucor (NYS: NUE) had to push its first-quarter guidance toward the low end of its previously announced range, while Steel Dynamics (NAS: STLD) similarly noted tight margins on steel production and had to rely on up-and-coming divisions such as metal recycling and rail production to pick up the slack. Rising iron ore prices also haven't helped the industry, as even global giant ArcelorMittal (NYS: MT) has seen similar problems -- along with some others related to its presence in crisis-ridden Europe.
Unlike Steel Dynamics and Nucor, though, AK Steel suffers from having severely negative cash flow. That not only bodes ill for the company's general financial health, but also puts its current dividend in jeopardy of being cut. With a massive debt-to-equity ratio, there's only so long AK Steel can maintain a dividend without producing the profits to fund it.
Another problem lies in AK Steel's pension funding. Like peer U.S. Steel (NYS: X) , AK Steel has a huge shortfall in meeting its unfunded pension liabilities. With the company struggling, it's unclear how AK Steel can hope to divert money toward shoring up its pension fund.
For AK Steel to recover, it needs to focus on profitability first and foremost. Unless it can get itself out of the red quickly, AK Steel may prove to be the weak link in the steel industry without ever having a chance to reach for 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.
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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 ArcelorMittal. Motley Fool newsletter services have recommended buying shares of Nucor. 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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