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 Moody's (NYS: MCO) 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 Moody's.
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%
6 out of 10
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Moody's last year, the company has held onto its six-point score. But the stock has done quite well, rising about 35% over the past year.
Moody's plays a key role in the financial markets, providing ratings that many institutions rely on to make investment decisions. Yet that's exactly what has gotten Moody's and peers Fitch Ratings and McGraw-Hill's (NYS: MHP) Standard & Poor's into trouble, as glowing ratings on Bank of America (NYS: BAC) , Citigroup, and many other top banks prior to the financial crisis proved to be overly optimistic. Despite the subsequent fallout, the industry has largely failed to make significant changes.
As a result, the influence that Moody's and other ratings agencies have over the markets has waned, at least among mainstream investors. Earlier this year, for instance, the company considered downgrading a host of banks. But as Fool analyst Matt Koppenheffer noted, the call seemed far too late to make any appreciable difference.
Nevertheless, the healthy credit markets are still bringing in plenty of business for Moody's. With bond issuance at record levels, more issuers need ratings, and Moody's gets its fair share of business from providing those ratings. That's a big part of why Berkshire Hathaway (NYS: BRK.B) owns the stock, and some believe Warren Buffett may add to his position in Moody's or even make a full acquisition.
For Moody's to improve, continued dividend increases would go a long way toward making the stock more attractive. Combine that with further revenue gains, and the path to perfection for Moody's, though difficult, is pretty clear.
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.
Sure, Moody's made a mistake on Bank of America, but it wasn't the only one. Now, though, the stock has recovered substantially. Is B of A a buy now, even after its run-up? To learn more about the most talked-about bank out there, check out our in-depth company report on Bank of America, which details the bank's prospects and gives three reasons to buy and three reasons to sell. Just click here to get access.
Click here to add Moody's to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.
The article Has Moody's Become the Perfect Stock? originally appeared on Fool.com.
Fool contributor Dan Caplinger owns shares of Berkshire Hathaway. The Motley Fool owns shares of Bank of America, Berkshire Hathaway, Citigroup, Moody's, and McGraw-Hill. Motley Fool newsletter services recommend Berkshire Hathaway and Moody's. 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.