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 if GlaxoSmithKline (NYSE: GSK ) 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 Glaxo.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||7.2%||fail|
|1-Year Revenue Growth > 12%||7.7%||fail|
|Margins||Gross Margin > 35%||74.5%||pass|
|Net Margin > 15%||13.5%||fail|
|Balance Sheet||Debt to Equity < 50%||155.3%||fail|
|Current Ratio > 1.3||1.49||pass|
|Opportunities||Return on Equity > 15%||41.4%||pass|
|Valuation||Normalized P/E < 20||14.46||pass|
|Dividends||Current Yield > 2%||5.2%||pass|
|5-Year Dividend Growth > 10%||8.8%||fail|
|Total Score||5 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Glaxo weighs in with a score of 5, putting it in the middle of the pack. Although the drug maker gets high marks for strong dividends at a good valuation, its growth and balance sheet leave a bit to be desired.
Pharmaceutical stocks have been a great place for dividend investors to seek nice payouts, and Glaxo is near the top of the pack. Among major pharma stocks, only Eli Lilly (NYSE: LLY ) pays a higher yield.
But the future looks more uncertain for Glaxo. Like many of its peers, it faces uncertainty about the impact of health care reform in the U.S., especially after the 2010 elections threw the recently passed health-care law back into play. As a British company, it's also closer to the unstable financial situation in Europe.
In addition, Glaxo recently suffered a near-complete loss on its diabetes drug, Avandia, with European regulators pulling the drug entirely, while the FDA put such strict limits on its sale that its revenues will likely plummet.
In Glaxo's favor, though, it doesn't have quite the same pipeline issues that Lilly, Merck (NYSE: MRK ) , and Pfizer (NYSE: PFE ) face in coming years. Pfizer will lose Lipitor, and Merck lost blood pressure medications Cozaar and Hyzaar to patent expirations. But Glaxo has most of its patent expirations behind it, and it has a well-balanced pipeline to help it keep moving forward.
Glaxo isn't the perfect stock. But for conservative investors looking for solid income, it's a good candidate.
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.
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