Saturday, August 18, 2012

Has Gerdau Become the Perfect Stock?

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 Gerdau (NYSE: GGB  ) 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 Gerdau.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 6.9% Fail
1-Year Revenue Growth > 12% 14% Pass
Margins Gross Margin > 35% 14.2% Fail
Net Margin > 15% 5.7% Fail
Balance Sheet Debt to Equity < 50% 50.8% Fail
Current Ratio > 1.3 2.68 Pass
Opportunities Return on Equity > 15% 8.7% Fail
Valuation Normalized P/E < 20 17.58 Pass
Dividends Current Yield > 2% 3.4% Pass
5-Year Dividend Growth > 10% (12.4%) Fail
Total Score 4 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Gerdau last year, the steel producer has kept the same score. Slightly faster revenue growth over the past year offset a drop in the company's dividend.

Gerdau makes steel in Brazil, which many investors have looked to as a potential growth opportunity. With Brazil hosting the World Cup in 2014 and the Summer Olympics in 2016, Gerdau and peer Companhia Siderurgica Nacional (NYSE: SID  ) both looked like smart ways to play the need for huge infrastructure investment that accompanies both those events.

But at least this year, Gerdau's shares have suffered greatly. Despite higher sales, costs have risen at an even faster pace, crimping margins and hurting profits. Yet that's a problem that several other companies have faced, and worldwide, ArcelorMittal (NYSE: MT  ) , U.S. Steel (NYSE: X  ) , and Steel Dynamics (Nasdaq: STLD  ) have all seen substantial losses in their shares as well. Nucor (NYSE: NUE  ) is one of the only steel producers to buck that trend, perhaps because of its more cost-conscious use of locally placed mini-mills and other corporate initiatives.

What Gerdau needs is improvement in both the world economy and Brazil's in particular. After fighting back waves of huge capital inflows and resulting inflation, Brazil may be getting a handle on its once-overheating economy -- and in doing so, it sets the stage for Gerdau to make a run closer to perfection in the years ahead.

Keep searching
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.

Click here to add Gerdau to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."

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