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 Cree (Nasdaq: CREE ) 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 Cree.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||20.5%||Pass|
|1-Year Revenue Growth > 12%||58.1%||Pass|
|Margins||Gross Margin > 35%||48.3%||Pass|
|Net Margin > 15%||20%||Pass|
|Balance Sheet||Debt to Equity < 50%||0%||Pass|
|Current Ratio > 1.3||10.77||Pass|
|Opportunities||Return on Equity > 15%||10.2%||Fail|
|Valuation||Normalized P/E < 20||32.43||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||6 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Cree computes a score of 6, which is a fairly typical result for most growth-oriented companies. Although Cree doesn't pay a dividend and currently carries a fairly rich valuation, it has put in some stellar growth in recent years.
Cree has followed the charge of semiconductor companies into energy efficiency applications. Just as MEMC Electronic Materials (NYSE: WFR ) has grown into making solar-energy materials, Cree has devoted substantial effort to producing high-efficiency light-emitting diodes (LEDs) for lighting applications, joining big-name competitors like General Electric (NYSE: GE ) .
In January, however, Cree's stock took a 15% hit after the company missed estimates on earnings and revenue and reduced future guidance. That also pushed shares of manufacturers Veeco Instruments (Nasdaq: VECO ) and Aixtron (Nasdaq: AIXG ) down. But with Veeco serving multiple users, it has broader exposure to the trend toward LEDs without the company-specific risks that Cree faces.
Nevertheless, Cree has put itself in the right place at the right time. If it can follow through on its good start, it could get a lot closer to perfection in the years ahead.
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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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.