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 Seadrill Ltd (NYSE:SDRL) 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 Seadrill.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-year annual revenue growth > 15%||21.1%||Pass|
|1-year revenue growth > 12%||0.9%||Fail|
|Margins||Gross margin > 35%||61.6%||Pass|
|Net margin > 15%||23.8%||Pass|
|Balance sheet||Debt to equity < 50%||177.7%||Fail|
|Current ratio > 1.3||0.79||Fail|
|Opportunities||Return on equity > 15%||16.5%||Pass|
|Valuation||Normalized P/E < 20||40.36||Fail|
|Dividends||Current yield > 2%||9%||Pass|
|5-year dividend growth > 10%||27.7%||Pass|
|Total score||6 out of 10|
Since we looked at Seadrill last year, the company has lost a point for the second year in a row, this time as revenue growth slowed. The shares managed a minimal rise of about 5% over the past year, not including the substantial dividends that the stock paid out as well.
Seadrill has tapped into the lucrative ultra-deepwater drilling segment, which has entirely different dynamics from traditional land-based drilling. With onshore rigs, drilling can be done in a matter of days, which can lead to fast and severe fluctuations in demand. But Seadrill and rival Transocean LTD (NYSE:RIG) benefit from contracts that can extend for years, given that each individual well can take months to drill and complete. Transocean has 10-year contracts with some of its customers for rigs that aren't even built yet, while Seadrill has half of its fleet locked up through 2017.
In particular, Seadrill has hitched itself to some promising long-term offshore plays. Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR) has contracted several submersible rigs to develop its Santos and Campos Basin holdings off the coast of Brazil, while similar plays across the Atlantic off the west coast of Africa have similar promise.
Most interesting is Seadrill's decision to offer shares of Seadrill Partners LLC (NYSE:SDLP) as a way to get direct exposure to particular drilling rigs. Yet despite the word "partners" in the name, the entity is organized as a limited liability company and has elected to be taxed as a corporation, removing many of the benefits that master limited partnerships enjoy. With the dividend yield below that of the original company, Seadrill Partners doesn't appear to pose a threat to Seadrill's attractiveness as an investment.
For Seadrill to improve, it needs to get its debt under control and work on boosting revenue further. Continued growth should push normalized earnings up and bring valuations down, but until that happens, Seadrill may not get much closer to perfection.
The article Has SeaDrill 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 Seadrill and Transocean.
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