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 Apollo Investment Corp. (NASDAQ:AINV) fits the bill.
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 and acknowledging that the company’s status as a business development company makes some of them less applicable than they would be to an ordinary corporation, let’s take a closer look at Apollo Investment.
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Growth | 5-year annual revenue growth > 15% | (0.6%) | Fail |
| 1-year revenue growth > 12% | (9.4%) | Fail | |
| Margins | Gross margin > 35% | 100% | Pass |
| Net margin > 15% | 46.9% | Pass | |
| Balance sheet | Debt to equity < 50% | 63% | Fail |
| Current ratio > 1.3 | 1.83 | Pass | |
| Opportunities | Return on equity > 15% | 9.6% | Fail |
| Valuation | Normalized P/E < 20 | 17.47 | Pass |
| Dividends | Current yield > 2% | 9.4% | Pass |
| 5-year dividend growth > 10% | (12.8%) | Fail | |
| Total score | 5 out of 10 |
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Apollo Investment last year, the company has picked up 2 points. An improving balance sheet and positive net margins were responsible for the score gains, and the shares have climbed almost 20% over the past year.
Business development companies have gotten a lot of attention lately because of their high distribution yields. With traits resembling private-equity investments, BDCs enjoy special tax breaks that encourage big payouts to income investors. For its part, Apollo’s focus lately has been on secured loans and subordinated debt, with a big stable of private companies among its investments.
Unfortunately for Apollo, one thing that stands out is its substantial reduction in payout over the past several years. By contrast, Main Street Capital Corporation (NYSE:MAIN) has maintained its streak of steadily rising monthly dividends since going public in 2007, and Ares Capital Corporation (NASDAQ:ARCC) recently raised its payout above the level it had paid in 2008, before the financial crisis forced it to reduce its distribution. Prospect Capital Corporation (NASDAQ:PSEC) cut its dividend in 2010, and it has since managed to increase that payout slightly, producing a more attractive yield for investors.
Yet as American Capital Ltd. (NASDAQ:ACAS) has shown with its no-dividend policy lately, total returns are more important than payouts. On that score, Apollo’s falling revenue is somewhat troubling, as most of its peers have seen gains.
For Apollo to improve, it needs to find ways to bolster its business to keep up with its competitors. If it can do so, though, it could well get itself closer to perfection in the years ahead.
The article Has Apollo Investment Become the Perfect Stock? originally appeared on Fool.com and is written by Dan Caplinger.
Fool contributor Dan Caplinger and The Motley Fool have no position in any of the stocks mentioned.
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