Has General Dynamics Become the Perfect Stock?
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 General Dynamics (NYS: GD) 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 General Dynamics.
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%
5 out of 10
Source: S&P Capital IQ. Total score = number of passes.
When we looked at General Dynamics last year, it did slightly better, scoring six points. The defense contractor has seen its current ratio slip below our target, and slow revenue growth and thin margins continue to plague the company.
The big threat to defense contractors throughout the industry is the current budget battle in Washington. Along with teammates Raytheon (NYS: RTN) and Lockheed Martin (NYS: LMT) , General Dynamics won a development contract to build a prototype of a new ground combat vehicle. Unfortunately, last month, the Senate Appropriations Committee made big cuts to the budget for the supertank, hurting not only those companies but also Northrop Grumman (NYS: NOC) , which had also won a prototype contract with teammate BAE Systems.
General Dynamics in particular had already seen some troubling trends. As Fool analyst Jim Mueller recently noticed, the company has seen its cash conversion cycle get a lot longer, with inventory turnover slowing at an alarming rate that's persisted over the long run. In addition, revenue growth has slowed even in advance of expected Defense Department budget cuts.
With valuations at rock-bottom levels, one possible profit opportunity for shareholders would be a buyout. Already, rumors that United Technologies (NYS: UTX) might buy up Textron (NYS: TXT) have pushed shares of the smaller contractor up, but Fool defense analyst Rich Smith thinks that General Dynamics might be closer to the size of company that United Tech is looking for.
For General Dynamics to reach perfection, it needs to find new growth avenues. For now, though, with the federal government trying to stand down, that doesn't look likely for the General or the rest of the defense industry in the near 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 the best investments from the rest.
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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."
At the time this article was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Lockheed Martin, General Dynamics, Northrop Grumman, Textron, and Raytheon. 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.
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