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 Patriot Coal (NYS: PCX) 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 Patriot Coal.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||15.9%||Pass|
|1-Year Revenue Growth > 12%||18.1%||Pass|
|Margins||Gross Margin > 35%||7.9%||Fail|
|Net Margin > 15%||(4.8%)||Fail|
|Balance Sheet||Debt to Equity < 50%||66.4%||Fail|
|Current Ratio > 1.3||0.99||Fail|
|Opportunities||Return on Equity > 15%||(15.3%)||Fail|
|Valuation||Normalized P/E < 20||NM||NM|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||2 out of 9|
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
With only two points, Patriot Coal isn't burning too brightly. The entire coal industry has suffered from competition from cheap natural gas, but it may be that coal stocks are hitting bottom.
This time last year, the future looked bright for coal. With huge demand for coal both for electricity generation and for industrial processes like steelmaking, coal producers foresaw good times well into the future. Peabody Energy (NYS: BTU) proposed a new West Coast coal export terminal to make it easier to export to Asian countries. It even made sense for Patriot and CONSOL Energy (NYS: CNX) , which are both located in the Appalachian region, to ship metallurgical coal all the way across the continent and the Pacific Ocean to meet Chinese demand.
But as China's growth forecasts started to slow, investors began to lose faith in the coal-demand growth story. And closer to home, low natural gas prices led to concerns that electrical utilities would reduce coal usage in favor of the cleaner-burning fuel. When Chesapeake Energy cut back on gas production, it boosted Patriot's shares temporarily, but they still remain at very low levels.
Things have gotten desperate enough that even rumors are moving coal stocks. Patriot rose almost 10% on Friday merely on speculation that Berkshire Hathaway (NYS: BRK.A) (NYS: BRK.B) might pick up coal stocks on the cheap. The synergies with its Burlington Northern railroad subsidiary would be interesting, but as fellow Fool Travis Hoium points out, there are several reasons why Warren Buffett investing in coal wouldn't make sense.
To get back to profitability, Patriot needs emerging-market demand for coal to start rising again, and ideally for the natural gas glut in the U.S. to end. Neither of those things appears likely to happen anytime soon, making Patriot potentially years away from getting much closer to perfection.
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 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 Chesapeake Energy. 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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