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Has Waste Management Become the Perfect Stock?

Thursday - 4/11/2013, 4:02pm  ET

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 Waste Management 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 Waste Management.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

0.5%

Fail

 

1-year revenue growth > 12%

2%

Fail

Margins

Gross margin > 35%

34.9%

Fail

 

Net margin > 15%

6%

Fail

Balance sheet

Debt to equity < 50%

149.2%

Fail

 

Current ratio > 1.3

0.80

Fail

Opportunities

Return on equity > 15%

13.2%

Fail

Valuation

Normalized P/E < 20

20.89

Fail

Dividends

Current yield > 2%

3.8%

Pass

 

5-year dividend growth > 10%

8.1%

Fail

       
 

Total score

 

1 out of 10

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

Since we looked at Waste Management last year, the company has dropped by three full points. Gross margins have dropped, sending returns on equity falling. Yet the share price has risen almost 15% over the past year, sending the stock's earnings multiple above 20.

Waste Management has the largest network of landfills in the country, helping it build a network effect that encourages municipalities and private companies to use its trash-hauling services as part of a package deal. But Waste Management was among the first trash companies to realize the full potential of recycling, and now, the company counts its recycling efforts as a major profit producer.

More recently, Waste Management has looked for further innovations in its business. Its landfills give it two potential energy sources, one from the gases that landfills produce, and a second from incinerating garbage to produce electricity. Rival Covanta pioneered the waste-to-energy movement and is the leading company in the space, but both Waste Management and No. 2 landfill operator Republic Services have pressed hard at building up their own renewable energy businesses. Moreover, Waste Management's partnership with Clean Energy Fuels to convert its hauling trucks to use natural gas brings the trash giant's renewable energy efforts full-circle.

Lately, investors have discussed some strategic moves Waste Management could make to bolster its growth. On one hand, some believe that the company could be a target for a massive acquisition in light of its reliable cash flow and industry-leading position. On the other hand, some have argued that Waste Management and Republic Services should spin their land and property assets into tax-favored real-estate investment trusts to bolster income and take advantage of higher multiples for REITs.

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