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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 Dolby Laboratories (NYSE: DLB ) 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 Dolby Laboratories.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||23%||Pass|
|1-Year Revenue Growth > 12%||24.2%||Pass|
|Margins||Gross Margin > 35%||87.8%||Pass|
|Net Margin > 15%||31.9%||Pass|
|Balance Sheet||Debt to Equity < 50%||0%||Pass|
|Current Ratio > 1.3||6.40||Pass|
|Opportunities||Return on Equity > 15%||20%||Pass|
|Valuation||Normalized P/E < 20||20.08||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||7 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Dolby manages to score seven points and comes just a hair away from an eighth. Although the company has faced some hard times lately, it has the dominant position in its industries to stage a comeback.
If it involves sound, odds are that Dolby has something to do with it. The company is the leading provider of audio entertainment technology, with a strong presence in the movie theater, consumer electronics, and software realms. Gaming represents a huge part of Dolby's business, with Microsoft (Nasdaq: MSFT ) representing 12% of Dolby's revenue and Sony (NYSE: SNE ) and Electronic Arts (Nasdaq: ERTS ) also among its customers.
One problem that Dolby has faced stems from the move from PCs to tablets like the iPad. Dolby has high-margin license agreements with notebook makers that it will now need to roll over to tablet makers. However, as companies like Netflix (Nasdaq: NFLX ) and Amazon.com (Nasdaq: AMZN ) bring more streaming video into homes, Dolby has an opportunity to make sure its sound technology remains an integral part of the home entertainment experience.
Despite its challenges, Dolby has quite a few attractive elements. Without a dividend, it isn't the perfect stock, but as the industry continues to expand, Dolby should have a place in it 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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