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 Xerox (NYSE: XRX ) 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 Xerox.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||7.3%||Fail|
|1-Year Revenue Growth > 12%||4.6%||Fail|
|Margins||Gross Margin > 35%||32.8%||Fail|
|Net Margin > 15%||5.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||69.8%||Fail|
|Current Ratio > 1.3||1.24||Fail|
|Opportunities||Return on Equity > 15%||10.7%||Fail|
|Valuation||Normalized P/E < 20||10.49||Pass|
|Dividends||Current Yield > 2%||2.2%||Pass|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||2 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Xerox last year, the company has lost a point. The company that once dominated the business equipment market now finds itself struggling to defend its turf from competition.
For nearly 50 years, Xerox has been synonymous with plain-paper copying. But more recently, computer printers have started to encroach on the copying segment, and that has opened the door to the strongest of the printer makers to compete directly with Xerox. Hewlett-Packard (NYSE: HPQ ) continues to lead the printer industry despite some of its internal troubles, while Canon (NYSE: CAJ ) and Lexmark (NYSE: LXK ) also pose what I'd argue are lesser competitive threats to Xerox from their printer production. As the formerly discrete segments start to merge together, it will be increasingly important for Xerox to distinguish itself on the printer front as well as with specialized copying equipment.
But the company is trying to branch out by providing IT services. Last month, the company got a contract worth more than $850 million from the Texas Department of Information Services, replacing IBM (NYSE: IBM ) in the process. Given that printing equipment is easier to make into a commodity product, building its IT services side is a smart move for Xerox to make (despite the fact that there's plenty of competition there, too).
For Xerox to start moving forward, it needs to regain some of the innovative spirit that made it a leader for decades. If it can do so, then the shares are poised to rise in response.
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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