Has Brocade Become 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 and then decide whether Brocade Communications (Nasdaq: BRCD  ) 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 Brocade.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 25.6% Pass
  1-Year Revenue Growth > 12% 4.1% Fail
Margins Gross Margin > 35% 59.7% Pass
  Net Margin > 15% 3.7% Fail
Balance Sheet Debt to Equity < 50% 37.9% Pass
  Current Ratio > 1.3 1.86 Pass
Opportunities Return on Equity > 15% 3.8% Fail
Valuation Normalized P/E < 20 49.77 Fail
Dividends Current Yield > 2% 0% Fail
  5-Year Dividend Growth > 10% 0% Fail
       
  Total Score   4 out of 10

Source: S&P Capital IQ. Total score = number of passes.

When we looked at Brocade last year, it scored slightly better, with 5 points. A slowdown in revenue over the past year is to blame for the slight downgrade, but that isn't the only challenge the storage-networking specialist is dealing with right now.

Earlier this year, it appeared that Brocade might benefit from trouble elsewhere in the industry. Networking giant Cisco (Nasdaq: CSCO  ) took it on the chin late last year after it wasn't able to provide investors with its typically large earnings beat, and with traditional Cisco customers IBM and Hewlett-Packard (NYSE: HPQ  ) jumping ship -- and IBM moving to resell more products from Brocade and Juniper Networks (NYSE: JNPR  ) -- it appeared that Brocade would take advantage of Cisco's woes.

But hasn't happened to the extent that investors hoped. HP has apparently decided to move itself out of the hardware business, and Brocade now cites falling revenue from the federal government as well as corporate IT spending weakness as hurdles for the stock going forward. Meanwhile, whispers of a buyout offer from IBM, HP, or Oracle have gotten a lot quieter.

In August, Brocade preannounced earnings that fell short of what analysts had expected, with a substantial revenue miss as well. The announcement also weighed heavily on storage pure-play NetApp (Nasdaq: NTAP  ) , which has even purer exposure to that niche of the market.

Brocade shareholders can't afford to count on a buyout to save their investment. What may end up making a difference is a cloud-computing-based initiative with partners EMC (NYSE: EMC  ) and VMware (NYSE: VMW  ) . If it works, the move may help Brocade break its downturn and get closer to perfection.

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 out the best investments from the rest.

Add Brocade 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 Cisco, IBM, EMC, and Oracle. Motley Fool newsletter services have recommended buying shares of Cisco and VMware. We Fools don't 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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