Is Forest Labs the Perfect Stock?

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 Forest Laboratories (NYSE: FRX  ) 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 Forest Labs.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 8.2% Fail
  1-Year Revenue Growth > 12% 6% Fail
Margins Gross Margin > 35% 78% Pass
  Net Margin > 15% 26.5% Pass
Balance Sheet Debt to Equity < 50% 0% Pass
  Current Ratio > 1.3 3.53 Pass
Opportunities Return on Equity > 15% 24.3% Pass
Valuation Normalized P/E < 20 9.85 Pass
Dividends Current Yield > 2% 0% Fail
  5-Year Dividend Growth > 10% 0% Fail
       
  Total Score   6 out of 10

Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.

With six points, Forest Labs doesn't have a perfect cure for your stock market worries, but it gives you a good start. The drug company has a good stable of lucrative moneymakers, but it's approaching patent expirations on some of its biggest products.

Forest Labs makes a variety of drugs, including depression treatment Lexapro and Alzheimer's drug Namenda. But the company faces two big problems. First, it faces huge competition on its existing stable of drugs. Among antidepressants, Eli Lilly (NYSE: LLY  ) has Cymbalta, and cheap generics like Pfizer's (NYSE: PFE  ) Zoloft and Lilly's Prozac also have a significant part of the market. And among Alzheimer's drugs, Pfizer and Eisai's Aricept as well as generic versions of Novartis' (NYSE: NVS  ) Exelon and Johnson & Johnson's (NYSE: JNJ  ) Razadyne also fight the disease.

More important for Forest, the company faces the expiration of its patents on Lexapro in 2012 and Namenda in 2015. That will leave Forest vulnerable to generic makers like Teva Pharmaceutical (Nasdaq: TEVA  ) and Mylan (Nasdaq: MYL  ) .

One solution would be for Forest to use its cash stash to scope out potential acquisitions. The company already bought drug developer Clinical Data earlier this year, and a follow-up buyout could help shore up its pipeline.

As with most drug companies, Forest needs to make sure new drug development keeps up with the inevitable loss of patent protection on its blockbusters. Unless it can, the stock's rock-bottom valuation is completely justified -- and Forest may never become a perfect stock.

Keep searching
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 the best investments from the rest.

Click here to add Forest Labs to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

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."

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Teva Pharmaceutical and Johnson & Johnson. Motley Fool newsletter services have recommended buying shares of Teva Pharmaceutical, Johnson & Johnson, Novartis, and Pfizer, as well as creating a diagonal call position in Johnson & Johnson. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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  • Report this Comment On September 20, 2011, at 1:22 PM, webmind wrote:

    If this is as close as you can come to the perfect stock, maybe it IS time to sell equities. Or just head to Vegas and have some fun while your at it.

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