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, and then decide if Penn West Petroleum (NYS: PWE) 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 Penn West Petroleum.
What We Want to See
Pass or Fail?
Five-year annual revenue growth > 15%
One-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%
Five-year dividend growth > 10%
3 out of 10
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Penn West Petroleum last year, the company has kept the same score. Although the company is back in the black on the earnings front, the stock hasn't performed all that well, falling 10% over the past year.
Like many natural-gas-heavy producers, Penn West has had a tough time dealing with rock-bottom gas prices. Just as Chesapeake Energy (NYS: CHK) and Devon Energy (NYS: DVN) have tried to shift their focus away from gas-producing properties toward more lucrative energy niches, Penn West has tried to turn things around by increasing its exposure to oil and natural-gas liquids, which now account for the majority of Penn West's production.
Penn West has also joined the wave of Canadian companies that have sold off assets in an effort to become more efficient. Both Talisman Energy (NYS: TLM) and Canadian National Resources (NYS: CNQ) have used asset sales to try to shift production away from dry gas, and Penn West's plans include selling $1.5 billion in assets, which it will apply toward reducing debt.
The sense of urgency comes from a big problem that Penn West faces. This year, the company successfully hedged much of its natural-gas exposure at favorable prices. But next year those hedges will drop by more than $1 per million cubic feet, leaving the company facing much lower revenue if natural-gas prices don't rise.
For Penn West to improve, it needs to keep emphasizing higher-priced oil and liquids production while getting costs better under control to boost margins. If it can do so and the energy markets cooperate, then Penn West could get back on the track toward perfection.
No stock is a sure thing, but some stocks are a lot closer to perfection than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate the best investments from the rest.
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The article Has Penn West Petroleum Become the Perfect Stock? originally appeared on Fool.com.