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 and then decide whether IBM (NYSE: IBM ) 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 IBM.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||3.4%||Fail|
|1-Year Revenue Growth > 12%||7.4%||Fail|
|Margins||Gross Margin > 35%||46.4%||Pass|
|Net Margin > 15%||14.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||128.3%||Fail|
|Current Ratio > 1.3||1.18||Fail|
|Opportunities||Return on Equity > 15%||69.3%||Pass|
|Valuation||Normalized P/E < 20||16.68||Pass|
|Dividends||Current Yield > 2%||1.7%||Fail|
|5-Year Dividend Growth > 10%||24.6%||Pass|
|Total Score||4 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With 4 points, Big Blue doesn't look all that big. But even if the tech giant's high-growth days are over, IBM is proving that it still has what it takes to compete in the industry.
IBM is well known for its hardware, spanning generations from electric typewriters to PCs and mainframe computers. What has helped IBM survive and thrive, however, is its increasing vertical integration, by which the company aims to deliver not just hardware to help customers establish a technology infrastructure but also the software and services they need to manage and maintain it.
That strategy has given IBM two things. First, it's helped IBM boost its margins over the years, helping with profitability. More importantly, IBM now has a moat against both hardware sellers Hewlett-Packard (NYSE: HPQ ) and Dell (Nasdaq: DELL ) and software giant Oracle (Nasdaq: ORCL ) , whose purchase of Sun Microsystems put it in position to compete against IBM.
Another source of strength comes from IBM's reach around the world. With almost two-thirds of its revenue coming from outside the Americas, IBM has more geographical diversity than even tech consultant Accenture (NYSE: ACN ) . In addition, while many tech companies either pay no dividend at all or are just now getting on the dividend bandwagon, IBM has been raising its dividend for 15 straight years.
With only modest growth and a decent amount of leverage on its balance sheet, IBM may find that its days of topping the perfect-stock list are gone for good. But the stock is still worth considering, especially for conservative investors who prefer tried-and-true companies with good income prospects.
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.