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 Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR) 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:
1). 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.
2). Margins. Higher sales mean nothing if a company can’t produce profits from them. Strong margins ensure that company can turn revenue into profit.
3). 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.
4). Moneymaking opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
5). 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.
6). 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 Petrobras.
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Growth | 5-year annual revenue growth > 15% | 10.5% | Fail |
| 1-year revenue growth > 12% | 15.2% | Pass | |
| Margins | Gross margin > 35% | 24.7% | Fail |
| Net margin > 15% | 7.5% | Fail | |
| Balance sheet | Debt to equity < 50% | 56.8% | Fail |
| Current ratio > 1.3 | 1.70 | Pass | |
| Opportunities | Return on equity > 15% | 6.2% | Fail |
| Valuation | Normalized P/E < 20 | 9.69 | Pass |
| Dividends | Current yield > 2% | 2.9%* | Pass |
| 5-year dividend growth > 10% | 5.1% | Fail | |
| Total score | 4 out of 10 |
Source: S&P Capital IQ. Total score = number of passes.
*Based on trailing 12-month payouts; see below.
Since we looked at Petrobras last year, the company has plunged 3 points, with weaker margins and balance sheet hurting its score. The stock has also suffered since we last looked at the stock, losing nearly half its value over the past year.
Brazil has been a tough place for oil companies lately. Rig counts are down, as the regulatory environment has been extremely harsh. Foreign producer Chevron Corporation (NYSE:CVX) got sued by the government for billions of dollars in damages after a minor oil spill, and the threat of similarly sensationalized regulatory crackdowns has led to reduced willingness among energy companies to take the risk of doing business there.
Petrobras in particular suffers from the fact that many of its most promising resources are in hard-to-reach areas offshore. As a result, it needs very high oil prices to justify the costs involved, and with massive debt approaching the $100 billion mark, the company has to be aware of financing costs that have sapped its bottom-line strength lately.
As a result, Petrobras has taken some drastic measures. Earlier this month, it announced that it would cut its dividend by more than half. The move will preserve cash to continue its ambitious investment plans, but it also shows the vulnerability of the company to current market conditions.
Problems at Petrobras could have a ripple effect across the industry. General Electric Company (NYSE:GE) has counted on its budding relationship with the oil giant to advance its own oil business, and deepwater drilling companies Seadrill Ltd (NYSE:SDRL) and Transocean LTD (NYSE:RIG) have both provided rigs for Petrobras projects. All of those companies are in danger of taking a hit if Petrobras can’t recover quickly.
For Petrobras to improve, it needs to do a better job developing its huge wealth of offshore resources. Combined with efforts to bring the Brazilian economy back to strength, Petrobras has plenty of potential to get back toward perfection in the years ahead.
The article Has Petrobras Become the Perfect Stock? originally appeared on Fool.com and is written by Dan Caplinger.
Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Petrobras and Seadrill and owns shares of General Electric, Seadrill, and Transocean.
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