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 Level 3 Communications (NYSE: LVLT ) 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 Level 3 Communications.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||5.1%||Fail|
|1-Year Revenue Growth > 12%||20.7%||Pass|
|Margins||Gross Margin > 35%||60.6%||Pass|
|Net Margin > 15%||(17.4%)||Fail|
|Balance Sheet||Debt to Equity < 50%||715.8%||Fail|
|Current Ratio > 1.3||1.03||Fail|
|Opportunities||Return on Equity > 15%||(159.7%)||Fail|
|Valuation||Normalized P/E < 20||NM||NM|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||2 out of 9|
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
With only two points, Level 3 Communications doesn't connect perfectly with investors. The Internet services company has made some big bets lately, and the big question is whether they'll pay off.
Level 3 has both a content-delivery service for the Internet as well as a fiber-optic network across the U.S. that it operates. Yet despite being in arguably one of the most exciting sectors of the economy, the company hasn't gone anywhere, with steadily worsening losses and alarming debt levels.
One key growth area for Level 3 has been becoming a primary content delivery network for Netflix (Nasdaq: NFLX ) in late 2010. Level 3 doesn't have that position exclusively; both Akamai (Nasdaq: AKAM ) and Limelight Networks (Nasdaq: LLNW ) share that role for the streaming video service provider. But given that Akamai thought two years ago that it would be the only provider for Netflix, Level 3 is clearly benefiting from the relationship, despite Netflix's recent woes.
Last year, Level 3 made a huge strategic move, buying rival Global Crossing for $1.9 billion. Yet with neither company having been profitable in years, it's unclear exactly how any advantages from the combination will pan out with net income.
In the long run, Level 3 desperately needs to figure out how to become profitable. With its huge debt load, however, that's going to be an uphill battle -- and arguably, investors' best exit strategy would be for a competitor seeking more bandwidth to buy out the company.
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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