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 Union Pacific (NYS: UNP) 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.
- 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 Union Pacific.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||4.3%||Fail|
|1-Year Revenue Growth > 12%||16.7%||Pass|
|Margins||Gross Margin > 35%||41.4%||Pass|
|Net Margin > 15%||16.4%||Pass|
|Balance Sheet||Debt to Equity < 50%||48.8%||Pass|
|Current Ratio > 1.3||1.17||Fail|
|Opportunities||Return on Equity > 15%||16.7%||Pass|
|Valuation||Normalized P/E < 20||15.02||Pass|
|Dividends||Current Yield > 2%||2.1%||Pass|
|5-Year Dividend Growth > 10%||21.1%||Pass|
|Total Score||8 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
Union Pacific does a great job of getting investors on down the tracks with its score of eight. The railroad company has benefited from a recovering economy as well as fuel prices that favor rail transportation over more energy-intensive methods.
Railroads are particularly sensitive to economic conditions for a simple reason: When the economy is strong, people need to move more things from place to place. Lately, Union Pacific and its peers have had plenty of stuff to move. Norfolk Southern (NYS: NSC) recently reported that coal and automotive shipments were up, while CSX (NYS: CSX) cited greater overall freight volume across its network. For Union Pacific, the company expects oil deliveries from the Bakken area of North Dakota to refineries on the Gulf Coast to jump by 300%. Berkshire Hathaway (NYS: BRK.B) , which bought Burlington Northern in 2009, cites strength at the railroad for favorable results at the company overall.
With those favorable tailwinds, Union Pacific remains attractive for a couple reasons. First, its valuation hasn't gotten very expensive despite its resilience. In addition, its dividend weighs in at a healthy 2% yield. That yield is slightly better than you'll find at Canadian National Railway (NYS: CNI) , although both CSX and Norfolk Southern top Union Pacific both on current yield and past dividend growth.
Even though energy costs crimp margins for railroads, they do a lot less damage to the bottom line than they do for trucking companies. So as long as the economy doesn't slip into recession, Union Pacific should continue to look like nearly a perfect stock.
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.
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At the time this article was published Fool contributor Dan Caplinger owns shares of Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway and Canadian National Railway. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.
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