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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 look at what you'd want to see from a perfect stock, and then decide whether Qualcomm (Nasdaq: QCOM ) 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 Qualcomm.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-year annual revenue growth > 15%||14.1%||Fail|
|1-year revenue growth > 12%||5.5%||Fail|
|Margins||Gross margin > 35%||68%||Pass|
|Net margin > 15%||29.5%||Pass|
|Balance sheet||Debt to equity < 50%||6.3%||Pass|
|Current ratio > 1.3||2.22||Pass|
|Opportunities||Return on equity > 15%||15.8%||Pass|
|Valuation||Normalized P/E < 20||33.99||Fail|
|Dividends||Current yield > 2%||1.5%||Fail|
|5-year dividend growth > 10%||17.6%||Pass|
|Total Score||6 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Qualcomm's score of six is pretty good. The company's success reflects its unique strategy toward building a dominant presence in the communications equipment industry. That approach that has produced strong long-term results.
Back in July, fellow Fool Eric Bleeker laid out the case in support of Qualcomm. As an industry pioneer, Qualcomm helped unify wireless providers under a single standard called CDMA. Ever since, Qualcomm has reaped royalties from its huge portfolio of patents, which providers have to license in order to be part of the standard.
But Qualcomm hasn't stood still, either. It has made great strides in becoming an essential part of Google's (Nasdaq: GOOG ) Android platform, which has become increasingly popular among new smartphones.
Some have been concerned that Qualcomm's dominance might wane as AT&T (NYSE: T ) and Verizon (NYSE: VZ ) begin moving toward 4G platforms, where Qualcomm's patent portfolio isn't as strong. But the major telecom companies are still making big investments in their legacy 3G networks, suggesting that Qualcomm should continue to reap big rewards well into the future.
Qualcomm's weak points right now are its fairly rich valuation and a subpar dividend yield. But with a payout ratio of just 37%, raising its dividend above 2% would be relatively easy if the company decides it wants to do so. And with projections for 17% growth over the next five years, its pricey earnings multiple could come down in a hurry. That may not make Qualcomm perfect right now, but it's a pretty attractive stock in a hot area.
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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