Is Demand Media 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 Demand Media (NYSE: DMD  ) 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 Demand Media.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 24.2%* Pass
  1-Year Revenue Growth > 12% 28.4% Pass
Margins Gross Margin > 35% 52.0% Pass
  Net Margin > 15% (5.7%) Fail
Balance Sheet Debt to Equity < 50% 0% Pass
  Current Ratio > 1.3 1.33 Pass
Opportunities Return on Equity > 15% (4.6%) Fail
Valuation Normalized P/E < 20 NM NM
Dividends Current Yield > 2% 0% Fail
  5-Year Dividend Growth > 10% 0% Fail
       
  Total Score   5 out of 9

Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes. * 4-year growth rate.

With five points, Demand Media scores in the middle of our scale. After a relatively poor year, the company saw a big earnings beat last week that could signal a reversal to its bad fortune.

Demand Media provides online content for the Internet. That's been a tough business for many publishers, as established companies seek to monetize their premium content. New York Times (NYSE: NYT  ) implemented its paywall, yet has still seen its stock languish. News Corp. (Nasdaq: NWS  ) and its Wall Street Journal has also tried to draw the line between providing limited free content while maintaining subscription revenue for in-depth use -- all the while trying to navigate its British phone-tapping scandal.

The difference, though, is that Demand Media has gotten a bad reputation, with some calling it a content mill. Google (Nasdaq: GOOG  ) went so far as to penalize Demand Media pages in its search algorithm, which resulted in a growth slowdown for Demand Media. Yet the company is far from the only one paying inexpensive freelancers to generate content. AOL (NYSE: AOL  ) has its Patch service that does much the same thing, yet its stock has recovered strongly in recent months.

Last week, Demand Media announced earnings that beat estimates, posting an adjusted profit versus an expected loss. The company also sees substantial growth coming in the first half of 2012.

Demand Media is far from a sure thing. But if it can deliver on the growth it hopes to see, it could get a lot closer to perfection in the near future.

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.

Demand Media may not be a perfect stock, but we've got some ideas you may like better. Let me invite you to learn about three smart long-term stock plays in the Fool's latest special report. It's yours for the taking and is absolutely free, but don't miss out -- click here and read it today.

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

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Google. Motley Fool newsletter services have recommended buying shares of Google. 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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