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 Capstone Turbine (NASDAQ: CPST ) 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 Capstone Turbine.
Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
Growth | 5-year annual revenue growth > 15% | 36.8% | Pass |
| � | 1-year revenue growth > 12% | 18.1% | Pass |
Margins | Gross margin > 35% | 6.9% | Fail |
| � | Net margin > 15% | (26.7%) | Fail |
Balance sheet | Debt to equity < 50% | 24.5% | Pass |
| � | Current ratio > 1.3 | 1.91 | Pass |
Opportunities | Return on equity > 15% | (73.1%) | Fail |
Valuation | Normalized P/E < 20 | NM | NM |
Dividends | Current yield > 2% | 0% | Fail |
| � | 5-year dividend growth > 10% | 0% | Fail |
| � | � | � | � |
| � | Total score | � | 4 out of 9 |
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
Since we looked at Capstone Turbine last year, the company has kept its four-point score for the third year in a row. But the stock has suffered, losing a third of its value in the past year.
On one hand, Capstone has done a good job of making revenue growth a priority. Although the nearly 37% annual growth over the past five years came off a small base, record order backlogs point to continued success in Capstone getting business for the foreseeable future. Success in weathering Hurricane Sandy when traditional utilities had massive outages for weeks following the storm also boosted Capstone's reputation.
Yet profitability has eluded Capstone. One problem is that truly large customers that want localized co-generation capability can turn to General Electric (NYSE: GE ) , Caterpillar (NYSE: CAT ) , or the Pratt & Whitney division of United Technologies. Each of those companies competes to provide big power plants that can support the needs of hospitals, manufacturing facilities, or collegiate institutions. By contrast, Capstone has a niche in provider options for smaller businesses and residential use, but those areas haven't ramped up yet.
The potential gold mine for Capstone comes from the energy industry, where the need for power in remote drilling locations is tailor-made for Capstone microturbines. With Chesapeake Energy (NYSE: CHK ) and EOG Resources (NYSE: EOG ) having made big orders for Capstone products to power their shale gas operations, the precedent has been set. With low natural-gas prices having curtailed production, though, the extensive capital expenditures necessary to get Capstone systems up and running haven't been on oil and gas producers' priority lists.
For Capstone to improve, it needs to work on convincing residential consumers and small businesses that its revolutionary power-distribution model is superior to the grid-based structure that current utilities use. That's a tall order, but if Capstone can pull it off, then the stock has plenty of room to recover.
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 out the best investments from the rest.
Capstone is laser-focused on small-scale power applications, but GE is the master at big power projects. Find out whether GE is the better buy in our premium research report, in which our industrials analyst breaks down GE's multiple businesses. You'll find reasons to buy or sell GE, and you'll receive continuing updates as major events unfold during the year. To get started, click here now.
Click here to add Capstone Turbine to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.
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