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 ARM Holdings (Nasdaq: ARMH ) 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 ARM Holdings.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||13.3%||Fail|
|1-Year Revenue Growth > 12%||21.0%||Pass|
|Margins||Gross Margin > 35%||94.4%||Pass|
|Net Margin > 15%||22.95||Pass|
|Balance Sheet||Debt to Equity < 50%||0%||Pass|
|Current Ratio > 1.3||2.26||Pass|
|Opportunities||Return on Equity > 15%||11.5%||Fail|
|Valuation||Normalized P/E < 20||82.36||Fail|
|Dividends||Current Yield > 2%||0.6%||Fail|
|5-Year Dividend Growth > 10%||28.3%||Pass|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at ARM Holdings last year, the company has kept its six-point score. Yet the chipmaker has developed a sizable lead in the mobile device market, one that competitors are scurrying to try to catch up on.
ARM Holdings has taken the chip market by storm. With its microprocessor designs used in Apple's (Nasdaq: AAPL ) iPhone and iPads as well as most Android-powered phones, the company has caught a huge wave of growth at a perfect time. That has put Intel (Nasdaq: INTC ) on the defensive, as it tries to build its own presence in the mobile market.
But ARM Holdings isn't content with its position in supplying mobile devices. The chipmaker is also working with Hewlett-Packard (NYSE: HPQ ) and Microsoft (Nasdaq: MSFT ) to get itself into Intel's traditional areas of strength: PC desktops, laptops, and servers. With HP trying to execute its own turnaround, it won't be in any hurry to help Intel as its ultrabook offerings compete with HP laptops. And with Microsoft having built its Windows 8 operating system to accommodate ARM chip designs, Intel can no longer count on the old "Wintel" combination to carry it forward.
At this point, ARM Holdings is still near the building of what could prove to be a huge move up in smartphone and tablet consumption over the next several years. If it can continue to build on its previous successes and lock in its strong position over the market, then ARM Holdings could keep up a faster growth rate and find itself moving closer to perfection in the years ahead.
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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