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 Toll Brothers (NYS: TOL) 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 Toll Brothers.
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 10
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Toll Brothers last year, the company has managed to double its score. That's a much bigger deal than it may seem, as a huge boost in sales has investors excited about the stock, which has more than doubled in the past year.
For years, Toll Brothers struggled along with the rest of the housing industry. But, as new home sales have finally started to rise, the homebuilder has seen a big jump in revenue over the past year, and that's helped the company put its money-losing years behind it and post a modest profit.
What sets Toll Brothers apart from its peers, though, is its relatively strong balance sheet. Although the debt-to-equity ratio remains above our 50% guideline, major rivals PulteGroup (NYS: PHM) , Lennar (NYS: LEN) , and Standard Pacific (NYS: SPF) have a whole lot more debt on their books compared to their shareholder equity. The relative stock performance may not reflect that, with more highly leveraged plays putting up even better returns than Toll Brothers. Hovnanian (NYS: HOV) , which sports negative shareholder equity and debt four times its market cap, has gained almost 150% in the past year. But, in terms of sustainability, Toll Brothers will have more room to expand when the good times return in earnest.
In its most recent quarter, Toll Brothers kept feeding the fire of hope for a lasting recovery. With earnings per share coming in at more than twice what analysts had expected, a rosier view of the housing market has started to pay off for the high-end homebuilder.
For Toll Brothers to improve, it really needs the housing recovery to be for real this time. Given the stock's massive earnings multiple, it'll take a lot of growth to justify the current share price.
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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The article Has Toll Brothers Become the Perfect Stock? originally appeared on Fool.com.
Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. Motley Fool newsletter services have recommended writing naked calls on Standard Pacific. 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.