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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 LinkedIn (NYSE: LNKD ) 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 LinkedIn.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||100.2%*||Pass|
|1-Year Revenue Growth > 12%||114.8%||Pass|
|Margins||Gross Margin > 35%||84.4%||Pass|
|Net Margin > 15%||2.3%||Fail|
|Balance Sheet||Debt to Equity < 50%||0%||Pass|
|Current Ratio > 1.3||3.20||Pass|
|Opportunities||Return on Equity > 15%||3.2%||Fail|
|Valuation||Normalized P/E < 20||656.60||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes. *Four-year growth.
With five points, LinkedIn makes some decent connections with perfection. The social media company has undoubtedly delivered strong growth and is marginally profitable, but a lot depends on how well the company executes in the future.
When most people talk about LinkedIn, they use it as an example of froth in the IPO market. After a big first-day pop, the shares have settled down, but it still trades well above its actual IPO offering price. That's something that fellow social-media phenom Groupon (Nasdaq: GRPN ) and Internet-radio provider Pandora Media (NYSE: P ) can't say, as they've both declined from their highs and from their initial offering prices.
But more important is the fact that, unlike Groupon and Pandora, LinkedIn can point to actual profits on its bottom line. Already, the network effects that boosted eBay's (Nasdaq: EBAY ) online auction site to become the premier U.S. player in the industry are pushing LinkedIn to the top of its class. As growth continues, those network effects will only become stronger.
That strength gives LinkedIn some unique opportunities. Recently, speculation has arisen that LinkedIn might jump in to buy Monster Worldwide (NYSE: MWW ) , which said that it's exploring strategic alternatives. The combination would give LinkedIn a formidable presence in the white-collar professional job recruiting space, as well as providing a huge boost in revenue and earnings that would bring the stock's sky-high valuation down.
LinkedIn is still very young, so perfection is still years away at best. But with a promising start, LinkedIn just needs to focus on turning its promising business into more profits. If it can do that, the rest should take care of itself.
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.
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