Nov 27, 2013 Is There A Perfect Stock?

by 5i Research

5i Research Is There A Perfect Stock?

By Peter Hodson
 

Investors often ask us for our single, best high-growth stock idea. Rather than building a portfolio of stocks, these investors are seeking the perfect stock to load up on.

Most investors only need one or two great companies in their lifetime to ensure long-term portfolio success (as long as they do not sell too soon), but, sorry, there isn't a perfect stock. If there were, you wouldn’t be able to buy it anyway, as sellers would never want to sell it.

But there are certain qualities to look for to determine whether a company is better than most. Here are five of them. The company examples we’ve chosen may or may not be great investments, but they certainly have at least one good character each. If you find a company with two or three of these points, then you really might be on to a good company.

Management Ownership/Experience So many people forget the basics. If a management team has great prior experience and a vested interest in their company, you might as well go along for the ride.

Enghouse Systems Ltd. (ESL/TSX) is a good example. Chief executive Steve Sadler has invested in and turned around many companies before, including Geac Computer Corp., which was sold in 2006 for $1-billion. Now, Mr. Sadler owns $141-million of stock in Enghouse, a software facilities management/mapping company. Enghouse continues to grow its earnings and dividend, which is no surprise to investors familiar with the executive team. Its one-year return? 104%.

Tight Control On Stock The perfect company, in our view, would never, ever issue new stock. Every time a company sells shares, it is giving away part of your profits to someone else. Why would you want that?

Take Algoma Central Corp. (ALC/TSX). The Great Lakes shipping company went public more than 50 years ago and has since never sold another share to outside investors. It does have a convertible debenture issue outstanding, but that’s the closest it has ever come to actually issuing equity. Algoma's one-year return: 33%.

WaterFurnace Renewable Energy Inc. (WFI/TSX) has issued some shares. Its share count is 12.2 million, up from 11.2 million in 2002, but over 10 years that is exceedingly small growth compared with most companies. WFI’s one-year return: 78%.

High Return on Equity Many academic types can argue up and down about financial ratios and how debt influences them. For us, however, ROE brings it right down to the basics: How much did the company make on what investors have put into the company?

Carfinco Financial Group Inc. (CFN/TSX), for example, showed an ROE of 52% in 2012. Its one-year return: 22%. Constellation Software Inc. (CSU/TSX), meanwhile, had an ROE of 36% last year and a one-year market return of 79%.

Performance in Recessions This is one of our favourite indicators. If a company can grow its earnings during a recession, then it clearly must be doing something right.

Home Capital Group Inc.  (HCG/TSX) grew per-share earnings in each of 2007, 2008 and 2009, in the middle of the financial crisis. Even more impressive, Home Capital is a company in the mortgage business, and we all know how that went during those dark times. Its ROE, by the way, was 25% last year, and its share count hasn’t changed much in 10 years. Its one-year return: 49%.

Priceline.com Inc. (PCLN/Nasdaq) is another good example. Here we have a travel company whose per-share earnings almost quadrupled between 2007 and 2010. Was anyone travelling back then? Apparently they still were. Priceline’s one-year return: 74%.

Have An Innovative (or Addictive) Product If a company sells a drug, it can often do well. Starbucks Corp. (SBUX/Nasdaq) has historically performed exceptionally well. Its one-year return: 63%. Altria Group Inc. (MO/NYSE) has for decades been a strong cash-flow generator despite the negatives associated with tobacco. Its one-year return: 26%.

Addicted customers are generally good for business, but innovation also helps. Apple Inc. (AAPL/Nasdaq) hasn’t done much recently, but few can argue with its innovation or stock price gains of the past decade. Netflix Inc. (NFLX/Nasdaq) came in with an innovative, disruptive technology, and has jumped to US$331 from US$21 in 2007, including a one-year return of 319%.

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