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Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Xerox (NYSE: XRX ) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- 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 mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. 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 Xerox.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-year annual revenue growth > 15%||6.6%||Fail|
|1-year revenue growth > 12%||42.5%||Pass|
|Margins||Gross margin > 35%||34.4%||Fail|
|Net margin > 15%||2.8%||Fail|
|Balance sheet||Debt to equity < 50%||74.0%||Fail|
|Current ratio > 1.3||1.35||Pass|
|Opportunities||Return on equity > 15%||6.5%||Fail|
|Valuation||Normalized P/E < 20||15.82||Pass|
|Dividends||Current yield > 2%||1.6%||Fail|
|5-year dividend growth > 10%||NM||NM|
|Total Score||3 out of 9|
Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful; Xerox started paying a dividend in 2007. Total score = number of passes.
With just three points, Xerox isn't copying the performance of more perfect stocks. The company that revolutionized photocopying now finds itself in a tough industry with plenty of competition, and that has taken its toll on Xerox's financial prospects.
At one point, Xerox dominated the corporate market for copiers to such an extent that "Xeroxing" a document became part of the English language. Starting as a photographic paper and equipment company, Xerox released the first desktop plain-paper copier in 1963, and followed with a color copier 10 years later.
Now, though, Xerox faces plenty of competition. With the computer-printer segment merging with copiers, Hewlett-Packard (NYSE: HPQ ) and Canon (NYSE: CAJ ) now compete directly against Xerox, along with printer specialist Lexmark (NYSE: LXK ) .
In the past year, Xerox has seen much faster growth than its competition. That comes mostly from its acquisition of Affiliated Computer Services, which expanded Xerox's reach into outsourcing of business processes and information technology. In doing so, Xerox hopes to add some diversity to its revenue stream, trying to move toward a higher-margin service-based model that companies like IBM (NYSE: IBM ) have executed so well.
For now, Xerox still has a lot of work to do. Until it turns the corner, investors should probably look elsewhere to try to find the perfect stock.
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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