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 Tellabs (Nasdaq: TLAB ) 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 Tellabs.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(6.1%)||Fail|
|1-Year Revenue Growth > 12%||(5.3%)||Fail|
|Margins||Gross Margin > 35%||41.3%||Pass|
|Net Margin > 15%||0.1%||Fail|
|Balance Sheet||Debt to Equity < 50%||9%||Pass|
|Current Ratio > 1.3||3.30||Pass|
|Opportunities||Return on Equity > 15%||0.1%||Fail|
|Valuation||Normalized P/E < 20||213.31||Fail|
|Dividends||Current Yield > 2%||1.9%||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; Tellabs started paying a dividend in February 2010. Total score = number of passes.
Tellabs can't call up perfection with only three points. The communications equipment maker not only faces a tough sales environment but also cutthroat competition within the industry.
Tellabs is at the forefront of the Internet revolution, providing the products and services that allow Internet service providers to offer voice and broadband data and video to their customers. Yet for all the obvious growth potential in the industry, Tellabs hasn't capitalized, and revenue has fallen dramatically over the past five years. That's especially frustrating when you see that rival Alcatel-Lucent (NYSE: ALU ) has seen much stronger growth, and even industry giant Cisco (Nasdaq: CSCO ) , which has had its own struggles, continues to see revenues rise.
The problem Tellabs faces is a trend toward its customers consolidating supply lines across fewer firms, which puts the specialized supplier at a disadvantage. Recently, AT&T (NYSE: T ) chose Alcatel-Lucent over Tellabs for a lucrative supply relationship. With giants like Alcatel and a joint venture between Nokia (NYSE: NOK ) and Siemens (NYSE: SI ) to deal with, Tellabs will have its hands full for the foreseeable future.
But the company isn't giving up. Yesterday, Tellabs announced somewhat promising quarterly results and a plan to cut costs. Yet fellow Fool Tim Beyers sees it as only the first of many such cost-cutting measures, and falling revenue again raises the specter that the company can't get out of its tailspin.
A company that can't earn profits from a promising industry raises lots of red flags. Unless Tellabs can make a stronger turnaround, you shouldn't expect it to reach perfection.
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."