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 Amazon (Nasdaq: AMZN ) 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 Amazon:
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||35.0%||Pass|
|1-Year Revenue Growth > 12%||40.6%||Pass|
|Margins||Gross Margin > 35%||22.4%||Fail|
|Net Margin > 15%||1.3%||Fail|
|Balance Sheet||Debt to Equity < 50%||23.3%||Pass|
|Current Ratio > 1.3||1.17||Fail|
|Opportunities||Return on Equity > 15%||8.6%||Fail|
|Valuation||Normalized P/E < 20||148.32||Fail|
|Dividends||Current Yield > 2%||0.0%||Fail|
|5-Year Dividend Growth > 10%||0.0%||Fail|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Amazon last year, the stock has dropped by two points. Falling returns on equity and a slightly weaker balance sheet account for the difference, as the online retailer pushes forward with its ambitious entry into the mobile-device market.
Amazon has taken command of the online-retail market, with sales that dwarf other major Internet websites. But just as important has been its move into cloud computing, where it competes against salesforce.com (NYSE: CRM ) and Rackspace Holding (NYSE: RAX ) . While Salesforce focuses on providing higher-end services and Rackspace relies on its Internet hosting service for much of its revenue, Amazon aims at providing utility-like services on an as-needed basis.
Despite its past success, the company is still acting boldly to cement its position in the ever-changing online environment. Its Kindle Fire offered a low-price alternative to Apple's (Nasdaq: AAPL ) iPad, and even though the device has undoubtedly hurt margins in the short run, Amazon has to believe that getting customers used to its platform will help drive sales in the longer term.
Also, Amazon took on streaming-content provider Netflix (Nasdaq: NFLX ) by building its own library of streaming content. Linked to the company's Amazon Prime service, which also offers free two-day shipping, the new service was partly responsible for Netflix's big plunge late last year. Moreover, by encouraging Prime membership, Amazon should see new shoppers come onboard due to the move.
The big question going forward is when Amazon will finally convert its long-term strategy into short-term profit. The stock's pricey valuation clearly reflects the belief that Amazon will eventually succeed. But unless you're convinced that there's enough growth potential to justify sky-high multiples, you may prefer to wait for a better price point before you think about buying the stock.
No stock is a sure thing, but some stocks are a lot closer to perfection 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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