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 Archer Daniels Midland (NYS: ADM) 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 Archer Daniels Midland.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||17.7%||Pass|
|1-Year Revenue Growth > 12%||28.5%||Pass|
|Margins||Gross Margin > 35%||4.7%||Fail|
|Net Margin > 15%||1.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||50.6%||Fail|
|Current Ratio > 1.3||1.84||Pass|
|Opportunities||Return on Equity > 15%||8.8%||Fail|
|Valuation||Normalized P/E < 20||12.30||Pass|
|Dividends||Current Yield > 2%||2.3%||Pass|
|5-Year Dividend Growth > 10%||10.4%||Pass|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Archer Daniels Midland last year, the company has made strong progress, with its score jumping three full points. Stronger growth and a rising dividend were responsible for the score boost, but balance-sheet improvement and a lower valuation are also healthy signs for the company.
ADM is involved in two increasingly important industries. On one hand, food production has been a major growth business, as high crop prices encourage farms to boost yields and improve their productivity. But ADM is also a big ethanol producer, and alongside Andersons (NAS: ANDE) and privately held Cargill, its ethanol revenue has risen sharply so far this year.
Rising food prices remain ADM's biggest threat. High corn prices have pressured earnings for some time. Moreover, over the next decade, an expected 50% increase in cocoa prices could hit both ADM's and Hershey's (NYS: HSY) margins hard, even though ADM already has razor-thin margins under current conditions. ADM has pricing power to pass on high costs to its customers to some extent, but the situation is likely to remain challenging.
Competition also remains fierce. Bunge (NYS: BG) is fighting with ADM in lucrative overseas markets, such as the Black Sea region of Russia. As ADM seeks to expand internationally, it will also face South America's Adecoagro (NYS: AGRO) and other companies that have impressive histories of serving those markets.
For ADM to keep improving, its biggest struggle will be to get its margins up. The nature of the food industry may keep ADM from ever reaching perfection, but it has the potential to stay on top for a long time even if favorable farm trends start to reverse in the future.
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 doesn't own shares of the companies mentioned in this article. 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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