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Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?
One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide whether PDL BioPharma (Nasdaq: PDLI ) fits the bill.
The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.
Some of the most basic yet important things to look for in a stock are:
- 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 don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
- Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
- Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
- Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. 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 PDL BioPharma.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||8.3%||fail|
|1-Year Revenue Growth > 12%||(0.5%)||fail|
|Margins||Gross Margin > 35%||100%||pass|
|Net Margin > 15%||44.3%||pass|
|Balance Sheet||Debt to Equity < 50%||NM||fail|
|Current Ratio > 1.3||1.12||fail|
|Opportunities||Return on Equity > 15%||NM||fail|
|Valuation||Normalized P/E < 20||7.06||pass|
|Dividends||Current Yield > 2%||17%||pass|
|5-Year Dividend Growth > 10%||NM||pass|
|Total Score||5 out of 10|
Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful; PDL BioPharma had negative equity over the period and paid no dividend five years ago. Total score = number of passes.
PDL BioPharma weighs in with a middling score of 5. But there's a lot that's interesting about this small company.
Perhaps the most obvious high point is the company's dividend payments. PDL BioPharma earns large royalty checks when other companies, including Elan (NYSE: ELN ) , Eli Lilly (NYSE: LLY ) , Genentech, and Seattle Genetics (Nasdaq: SGEN ) , sell products based on its humanized antibody patents. In turn, PDL BioPharma returns a large portion of the resulting cash flow to shareholders in the form of special dividends.
But that reliance on royalty income also makes the company vulnerable. Its patents expire in late 2014; beyond that, the company's future is unclear. That explains the low valuation, as well as the troubling balance sheet, with negative shareholder equity and a debt-to-capital ratio of more than 300%.
If PDL BioPharma can leverage its intellectual property to produce an income stream beyond 2014, it could become a perfect stock. For now, though, the uncertainty has investors thinking twice before jumping in.
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.