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 Dynegy (NYS: DYN) 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 Dynegy.
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. *Reflects elimination of reported debt in company filings as of June 30, immediately before July 6 bankruptcy filing.
Since we looked at Dynegy last year, the company has nominally gained a point. But the gain comes as a direct result of Dynegy having filed for bankruptcy, and it's important for investors to understand that the shares that trade now aren't the same shares that traded before the filing.
Last year, Dynegy found itself in an interesting situation. On one hand, its subsidiaries were struggling under huge debt loads, and several filed for bankruptcy last November in the hopes of breaking costly lease agreements with Public Service Enterprise Group (NYS: PEG) . Moreover, initially, it appeared that the Dynegy parent entity, which represented the publically traded shares, might survive unscathed. Even with the company having previously turned down buyout offers from Blackstone Group (NYS: BX) and Icahn Enterprises (NAS: IEP) , activist investor Carl Icahn retained a substantial stake in the company and hoped to earn a big profit at the expense of bondholders.
The bankruptcy court governing Dynegy's subsidiaries' cases disagreed, calling the parent company's movement of assets a fraudulent transfer. That term of art in bankruptcy law doesn't match up with what most people think of as fraud, but the effect was to render Dynegy's strategy ineffective. By July, Dynegy was forced into bankruptcy as well.
After the company came out of bankruptcy earlier this month, new shares of Dynegy started trading. Under the reorganization plan, bondholders got the lion's share of the company's assets, and shareholders were nearly -- but not entirely -- wiped out. For every 1,000 shares of old Dynegy stock owned, shareholders will receive about 8.14 shares of new Dynegy stock, plus warrants to buy about 127 additional shares at a price of $40 anytime between now and October 2017. With shares currently trading below $20, it'll take a nice gain for those warrants finish in the money.
Looking forward, Dynegy should now operate with a new lease on life, leaving it better able to compete against fellow energy generators Calpine (NYS: CPN) and NRG Energy. That could push Dynegy closer to perfection in the coming years, but it's still important to remember that last year's shareholders have lost nearly everything regardless of what happens to Dynegy in the future.
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.
With the swelling of the global middle class, energy consumption will skyrocket over the next few decades, and long-term investors know that you want exposure to this space now. We've picked one incredible natural gas company that presents a rare "double-play" investment opportunity today. We're calling it The One Energy Stock You Must Own Before 2014, and you can uncover it today, totally free, in our premium research report. Click here to read more.
Click here to add Dynegy to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.
The article Has Dynegy Become the Perfect Stock? originally appeared on Fool.com.
Fool contributor Dan Caplinger has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.