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 Charles Schwab Corp (NYSE:SCHW) 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). Money-making 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 Schwab.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-year annual revenue growth > 15%||(0.7%)||Fail|
|1-year revenue growth > 12%||2.6%||Fail|
|Margins||Gross margin > 35%||93.5%||Pass|
|Net margin > 15%||19.3%||Pass|
|Balance sheet||Debt to equity < 50%||18.8%||Pass|
|Current ratio > 1.3||0.58||Fail|
|Opportunities||Return on equity > 15%||10.8%||Fail|
|Valuation||Normalized P/E < 20||25.37||Fail|
|Dividends||Current yield > 2%||1.4%||Fail|
|5-year dividend growth > 10%||3.7%||Fail|
|Total score||3 out of 10|
Since we looked at Schwab last year, the company has given back both points it gained from 2011 to 2012. Valuations rose and dividend growth fell, but investors have been quite happy with the stock, as it has risen by about 30% over the past year.
As a discount broker, Schwab makes money when its customers are excited about investing. Although the company has done a good job of bringing in new accounts and assets, daily average trading volume was relatively weak throughout much of 2012, as low trading volumes on major U.S. stock exchanges hurt activity levels overall. More recently, though, activity has started to pick up, with Schwab reporting gains of nearly 17% in average trading volume from November to January. Moreover, massive outflows from mutual funds throughout 2012 reversed themselves last month as investors reacted to big gains in the stock market.