In this Motley Fool series, we rank three related stocks on five criteria to determine the best buy.
Today's matchup is a knock-down, drag out among three completely different companies that have one thing in common: the market has beaten down their stock prices.
We're pitting Big Oil company BP (NYSE: BP ) vs. movie slinger Netflix (Nasdaq: NFLX ) vs. megabank Bank of America (NYSE: BAC ) .
BP is still reeling from its 2010 Deepwater Horizon oil spill in the Gulf of Mexico. More recently, Netflix is reeling from its Qwikster incident, and Bank of America is working through issues borne of the financial crisis and bad press from Occupy Wall Street and moves like charging a monthly fee for debit cards.
By using five short-of-scientific-but-carefully-chosen criteria, let's determine which of these three stocks is most poised for a comeback (assuming we have to buy one).
Round 1: Balance sheet
This one is actually pretty easy. Netflix has more cash than debt on its balance sheet, so it's the runaway winner here. BP employs a reasonable amount of debt (30% of capital), but it still faces regulatory and litigation uncertainty from its oil spill. Bank of America is leveraged at 10:1 on an assets/equity basis, which is actually pretty common and reasonable for a bank, but as we learned during the financial crisis, the balance sheets of the largest banks like B of A, Citigroup (NYSE: C ) , and JPMorgan Chase (NYSE: JPM ) are pretty much impossible to fully grasp. Some amount of faith in management has to be used to invest in the banks. Rank: (1) Netflix, (2) BP, (3) Bank of America.
Round 2: Operations
When looking at return on equity or net margins, Netflix is tops, but we also have to factor in the fact that Netflix competes in the most fluid, unknowable market. Energy and banking can be disrupted, but Netflix needs to pay up for content and the threat from Amazon.com (Nasdaq: AMZN ) , Apple, Google, Hulu, and upstarts make its operations future hard to predict. BP is the winner here because it's profitable (Bank of America isn't on a trailing-12-months basis) and its competitive landscape is relatively stable. Rank: (1) BP, (2) Netflix, (3) Bank of America.
Round 3: Biggest upside
A catalyst for BP is the resolution of litigation, which will play itself out over years (or decades), but more immediately BP can curry favor with investors with strong performance and by raising its dividend, which already yields 4.1%.
We saw how quickly investor sentiment could shift on Netflix, as it fell from $300 a share to the low-$100s in just months when the business fundamentals really didn't change much. Good news or consistent performance could spur the opposite. You can see this in Starbucks (Nasdaq: SBUX ) , whose stock plummeted to the single digits a few years ago. A lot of that was the financial crisis, but investors were also fearful on growth prospects. Starbucks has done enough through operations to rebound strongly back above $40 a share.
Bank of America has too many possible catalysts to list them all. But they include getting some better clarity on its exposure to bad past lending, resolution on mortgage-related litigation, a strong quarter or two, better public relations, or the ability to raise its dividend.
Bank of America is the most beaten-down of the stocks (it's trading at well less than half of its book value), and it proportionally has the biggest upside. Meanwhile, Netflix's growth-stock status (it still trades at a P/E of 30) means we could see wild swings from here. That goes for both the short and long terms. I believe, rather surprisingly, that BP has the least upside here. Stay tuned for the next category, though.
Rank: (1) Bank of America, (2) Netflix, (3) BP.
Round 4: Safest bet
Although I believe BP has the smallest upside, I also think it is the safest bet of a decidedly risky bunch. Oil majors like BP and ExxonMobil (NYSE: XOM ) periodically face issues like oil spills, difficulties with foreign governments, and tightening regulations. However, until or unless viable energy alternatives mature, fossil fuels will continue to be needed to sustain and grow the world's economic output.
Banking will also be around for a long time, but the long-term future of Bank of America isn't so ironclad. Sometimes too-big-to-fail can be failed (see Lehman Brothers).
As we discussed earlier, the future for Netflix is, in my mind, the most tenuous because it's competing with major players that are all quite competent. As content is increasingly delivered over the Internet, differentiation will become harder (read: more costly) to achieve. The power of a red envelope could crumple on the Web.
Rank: (1) BP, (2) Bank of America, (3) Netflix.
Round 5: CAPS rating
Out of a maximum of five stars, our CAPS community rates BP four stars, Bank of America three stars, and Netflix two stars. Rank: (1) BP, (2) Bank of America, (3) Netflix.
The summary rankings
| Category | BP | Netflix | Bank of America |
|---|---|---|---|
| Balance sheet | 2 | 1 | 3 |
| Operations | 1 | 2 | 3 |
| Biggest upside | 3 | 2 | 1 |
| Safest bet | 1 | 3 | 2 |
| CAPS rating | 1 | 3 | 2 |
| Average finish | 1.6 | 2.2 | 2.2 |
BP wins, with Netflix and Bank of America tying for second. I found this exercise interesting, because I own two of the three stocks: BP and Bank of America. Both seem like good bets to me if you've done your due diligence and can handle the risk. I haven't been a big fan of Netflix the stock, but it's a longtime Motley Fool Stock Advisor recommendation of Fool co-founder David Gardner, and it's still up more than 600% from when he first recommended it.
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