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 PPL Corporation (NYSE:PPL) 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.
- 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 PPL.
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Growth | 5-year annual revenue growth > 15% | 13.7% | Fail |
| 1-year revenue growth > 12% | (3.5%) | Fail | |
| Margins | Gross margin > 35% | 37.2% | Pass |
| Net margin > 15% | 12.4% | Fail | |
| Balance sheet | Debt to equity < 50% | 191.7% | Fail |
| Current ratio > 1.3 | 0.90 | Fail | |
| Opportunities | Return on equity > 15% | 14.2% | Fail |
| Valuation | Normalized P/E < 20 | 13.50 | Pass |
| Dividends | Current yield > 2% | 4.8% | Pass |
| 5-year dividend growth > 10% | 3.4% | Fail | |
| Total score | 3 out of 10 |
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at PPL last year, the company gave back the point it gained from 2011 to 2012. Revenue fell, but the stock managed to gain almost 10% over the past year.
PPL serves customers across a wide geography, but with substantial service in Pennsylvania, the utility had to deal with big outages due to Hurricane Sandy. About half a million customers were affected, but the company didn’t even mention the incident in its most recent quarterly report, making it clear that PPL doesn’t see the episode as having a substantial financial impact.
One concern with PPL is that it has had to issue new debt in order to finance dividend payouts. Despite generating substantial cash from operations and having an attractive earnings payout ratio, PPL’s massive capital expenditures in 2012 led to negative free cash flow for the year. With an already high debt-to-equity ratio, PPL needs to stay aware of the ongoing threat to its balance sheet. Nevertheless, that didn’t stop PPL from boosting its dividend last week by about 2%.
Looking forward, PPL is hoping to get growth from smart-grid technology. Increasingly, smart grid plays are drawing attention in the utility sector. Exelon Corporation (NYSE:EXC) is spending billions across its network of regional subsidiaries to install smart meters, modernize substations, and provide for variable pricing to customers who can take advantage of peak and off-peak usage trends. Meanwhile, Duke Energy Corp (NYSE:DUK) has signed on with a team of smart-grid players to get the benefits of the technology. For PPL’s part, it’s working with General Electric Copany (NYSE:GE) to upgrade its Pocono-region substations to shorten outage durations and prevent disruptions like the one that Hurricane Sandy caused.
For PPL to improve, it needs to follow through on its optimistic earnings forecast for 2013 and take steps to control its balance sheet better. If its smart-grid moves pay off and its U.K. business performs well, PPL could start moving back toward perfection in the years ahead.
The article Has PPL 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 Exelon. The Motley Fool owns shares of General Electric.
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