Is Amazon.com the Perfect Stock?

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.

Factor

What We Want to See

Actual

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.

Keep searching
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.

Click here to add Amazon.com to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our 13 Steps to Investing Foolishly.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Amazon.com and Netflix are Motley Fool Stock Advisor selections. Rackspace Hosting is a Motley Fool Rule Breakers recommendation. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 05, 2011, at 2:39 PM, sckessl53 wrote:

    Merrill Lynch just downgraded Amazon’s stock! DO NOT BUY AMZ IT IS LOSING SALES! Amazon is losing customers by the thousands. Walmart will be taking over almost all internet sales! Watch what happens in the next 4 months.

  • Report this Comment On June 05, 2011, at 2:43 PM, sckessl53 wrote:

    Amazon Downgraded By UBS. Do no buy Amz as they are losing hundreds of customers. Their sales are off 44% for the last quarter. Amazon will never tell you they are failing. I know they are.

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