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 Amazon.com (Nasdaq: AMZN ) 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 Amazon.com.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||32.1%||Pass|
|1-Year Revenue Growth > 12%||39.6%||Pass|
|Margins||Gross Margin > 35%||22.3%||Fail|
|Net Margin > 15%||3.4%||Fail|
|Balance Sheet||Debt to Equity < 50%||9.4%||Pass|
|Current Ratio > 1.3||1.33||Pass|
|Opportunities||Return on Equity > 15%||19%||Pass|
|Valuation||Normalized P/E < 20||82.31||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||5 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Amazon weighs in with a midrange score of 5. Although long-term shareholders have gotten rich by investing in the online retail giant, those looking to get in now have to weigh sky-high valuations and a lack of dividend income against the company's strong future growth prospects.
Amazon is best-known for its online shopping website, but it has its fingers in a bunch of different pies. With its Kindle, it has helped establish a thriving e-book market that has helped put rival Barnes & Noble (NYSE: BKS ) almost down for the count . Its cloud-computing business is the low-end leader in the area, forcing competitor Rackspace (NYSE: RAX ) to differentiate itself on providing higher service to capture higher-margin business.
Most recently, Amazon decided to go head-to-head with Netflix (Nasdaq: NFLX ) by offering streaming video free to its Amazon Prime premium subscribers. Although some see the move as a strategic mistake, Amazon hasn't hesitated to experiment with new ideas and has shown the discipline to reverse course when things don't work out.
Retail is by its nature a low-margin business, and with no dividend and shares going for a pricey multiple to trailing earnings, Amazon misses out on several points that would make it closer to perfect. The primary question going forward is whether the company can continue growing as fast as its valuation suggests it will. If it does, then shareholders should keep reaping benefits for years to come.
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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