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 whether Travelers 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.
Moneymaking 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 Travelers.
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%
3 out of 10
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Travelers last year, the company has picked up a point. But the stock has done a lot better than that, climbing more than 40% over the past year as the property and casualty insurance company had a much better year in 2012 than it did in 2011.
Travelers' impressive performance is somewhat surprising given the fact that Hurricane Sandy had huge economic impact on the Northeast in late 2012, just as Hurricane Irene did in 2011. Certainly, the damage caused by Sandy was extensive, with Travelers and rivals Allstate and Chubb each reporting losses related to Sandy in the neighborhood of $1 billion during the fourth quarter of 2012. Yet share prices of all three companies barely paused in their upward moves, shrugging off losses as an inevitable aspect of their business models.
The difference this time around for Travelers and its peers is that insurers are in a more favorable rate environment now. 2011's disasters caught the industry by surprise after a period during which premiums had been relatively low. But 2011's bad experience gave insurance companies the chance to raise rates dramatically, and that positive pricing environment helped build bigger loss-reserve cushions against events like Sandy.
Still, with favorable rates will come heightened competition. Notably, AIG has accomplished much of the restructuring it needed to do after the financial crisis, and AIG's P&C insurance business has the scope to compete favorably with Travelers.
For Travelers to improve, it needs better investment conditions to allow it to raise its return on equity. Once that happens, a slightly faster rate of dividend growth could also help Travelers get a little closer to 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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The article Has Travelers Become the Perfect Stock? originally appeared on Fool.com.
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