Tuesday, December 18, 2012

Has FirstEnergy 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, and then decide whether FirstEnergy (NYSE: FE  ) 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 the 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 FirstEnergy.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

5.6%

Fail

1-year revenue growth > 12%

4.3%

Fail

Margins

Gross margin > 35%

54.2%

Pass

Net margin > 15%

6.5%

Fail

Balance sheet

Debt to equity < 50%

139.1%

Fail

Current ratio > 1.3

0.63

Fail

Opportunities

Return on equity > 15%

7.7%

Fail

Valuation

Normalized P/E < 20

16.82

Pass

Dividends

Current yield > 2%

5.3%

Pass

5-year dividend growth > 10%

1.9%

Fail

Total score

3 out of 10

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

Since we looked at FirstEnergy last year, the company has given back the point it gained from 2010 to 2011, as revenue growth slowed. The stock has been equally disappointing, with a loss of about 5% over the past year.

FirstEnergy is a fairly typical utility that generates, transmits, and distributes electricity. Electricity generation has been a hit-or-miss proposition over the past year: FirstEnergy and Southern Company (NYSE: SO  ) successfully outpaced Exelon (NYSE: EXC  ) and NRG Energy (NYSE: NRG  ) throughout much of the first half of the year as FirstEnergy capitalized on above-average summer temperatures.

But Hurricane Sandy put a big roadblock in FirstEnergy's success story. With FirstEnergy's Jersey Central Power & Light having been in the direct path of the storm, millions of customers were without power, forcing FirstEnergy and Northeast Utilities (NYSE: NU  ) to make huge deployments of repair crews to clean up and get power restored.

In addition, dividend stocks throughout the market are under pressure from the fiscal cliff. With the potential for taxes on dividends to nearly triple next year, some investors are fleeing utilities and other high-income stocks, leaving FirstEnergy and its utility peers at what could be bargain prices.

For FirstEnergy to improve, it needs to work hard to make a full recovery from the effects of Sandy and do its best to navigate the shifting economic climate. In the long run, FirstEnergy should benefit from its strategic location and the rising long-term trend in rising power demand.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfection 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.

With all the work FirstEnergy has to do, you might want to look at its competitors. Exelon in particular is perfectly positioned to capitalize on the clean-energy trend, having the largest nuclear fleet in North America. The utility's recent merger with Constellation places�Exelon and its best-in-class dividend on a short list of top industry players. To determine whether Exelon is a good long-term fit for your portfolio, you're invited to check out The Motley Fool's premium research report on the company. Simply�click here now�for instant access.

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

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