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 Electronic Arts (Nasdaq: ERTS ) 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 Electronic Arts.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||4.0%||Fail|
|1-Year Revenue Growth > 12%||(1.8%)||Fail|
|Margins||Gross Margin > 35%||58.2%||Pass|
|Net Margin > 15%||(7.7%)||Fail|
|Balance Sheet||Debt to Equity < 50%||0.0%||Pass|
|Current Ratio > 1.3||1.52||Pass|
|Opportunities||Return on Equity > 15%||(10.4%)||Fail|
|Valuation||Normalized P/E < 20||NM||NM|
|Dividends||Current Yield > 2%||0.0%||Fail|
|5-Year Dividend Growth > 10%||0.0%||Fail|
|Total Score||3 out of 9|
Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful due to negative earnings. Total score = number of passes.
With just three points, Electronic Arts won't show up on your high-score stock list. The video game maker has struggled against a tough environment for years now, and big competition still looms from several corners.
If you just looked at the most recent quarter, you might think that times for video games had never been better. EA, Take-Two Interactive (Nasdaq: TTWO ) , and Activision Blizzard (Nasdaq: ATVI ) all beat expectations in their most recent quarterly reports.
The problem, though, is that a horrible couple of years has tempered those expectations. With huge double-digit drops in sales in 2009 and 2010, 2011 comps may look good, but both software companies like EA and game hardware makers like Microsoft (Nasdaq: MSFT ) and Sony (NYSE: SNE ) still have plenty of ground to recover.
But the company is answering the call of the changing industry. Last month, Electronic Arts announced that it would make it possible for gamers to download PC games directly from the company rather than going through stores. That's obviously bad news for retailers like GameStop (NYSE: GME ) , but as free and low-cost game options via social networks and smartphones proliferate, premium-game makers have to get every penny they can.
With the IPO of Zynga coming soon, the video game industry is going through a big revolution. EA may emerge victorious, but until it does, it isn't going to look like 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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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."