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 BHP Billiton Limited (ADR) (NYSE:BHP) 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 BHP Billiton Limited (ADR) (NYSE:BHP).
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Growth | 5-year annual revenue growth > 15% | 5.4% | Fail |
| 1-year revenue growth > 12% | (10.8%) | Fail | |
| Margins | Gross margin > 35% | 76.2% | Pass |
| Net margin > 15% | 14.3% | Fail | |
| Balance sheet | Debt to equity < 50% | 52% | Fail |
| Current ratio > 1.3 | 1.13 | Fail | |
| Opportunities | Return on equity > 15% | 14.6% | Fail |
| Valuation | Normalized P/E < 20 | 14.51 | Pass |
| Dividends | Current yield > 2% | 3.1% | Pass |
| 5-year dividend growth > 10% | 15.3% | Pass | |
| Total score | 4 out of 10 |
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at BHP Billiton last year, the company has plunged by four points, with falling revenue, net margins, and returns on equity combining with a rising debt-to-equity ratio. The stock hasn’t performed nearly as badly, but it has still posted a small loss over the past year.
As the world’s largest mining company, BHP Billiton has gotten hit especially hard by the drop in demand for the many commodities that it produces. In particular, low prices for iron ore and metallurgical coal were major culprits in the company’s 48% drop in net operating cash flow during the second half of 2012.
Yet BHP Billiton Limited (ADR) (NYSE:BHP) managed to avoid some of the miscues that its competitors made simply by not trying to get any larger than it already is. By contrast, Rio Tinto plc (ADR) (NYSE:RIO)‘s acquisition of Alcan seemed like a wise buy at the time, but the weakness in the aluminum market has forced the company to take massive impairment charges. Similarly, ill-advised acquisition activity from Cliffs Natural Resources Inc. (NYSE:CLF) led it to slash its dividend by more than 75% last month, with its concentration on met-coal and iron ore weighing on the company’s results. Because of its prudent capital management, BHP was able to raise its dividend last month.
Another thing that has helped BHP shine is its energy exposure. With substantial oil and natural gas assets, BHP isn’t as vulnerable to the whims of the metals markets as more concentrated miners. The strategy has been successful enough to inspire Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) to take the same tack with its plans to acquire two energy-related companies.
For BHP Billiton Limited (ADR) (NYSE:BHP) to improve, it needs a global recovery in metals and energy prices to help it boost its revenue. Until then, BHP can take advantage of its superior capital position to grab up assets on the cheap and put itself in better position to reap profits during the next cyclical upturn.
Keep searching
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.
The article Has BHP Billiton Become the Perfect Stock? originally appeared on Fool.com.
Fool contributor Dan Caplinger and The Motley Fool own shares of Freeport-McMoRan Copper & Gold.
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