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 Rosetta Stone (NYSE: RST ) 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 Rosetta Stone.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||24%||Pass|
|1-Year Revenue Growth > 12%||3.7%||Fail|
|Margins||Gross Margin > 35%||81.7%||Pass|
|Net Margin > 15%||(7.4%)||Fail|
|Balance Sheet||Debt to Equity < 50%||0%||Pass|
|Current Ratio > 1.3||1.94||Pass|
|Opportunities||Return on Equity > 15%||(11.4%)||Fail|
|Valuation||Normalized P/E < 20||NM||NM|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||4 out of 9|
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
Since we looked at Rosetta Stone last year, the company has maintained its four-point score. But a year-ago profit has turned into a loss as the language expert hasn't been able to translate its product line into sales growth.
Rosetta Stone is the best-known brand of language-instruction software and services in the U.S., with efforts to promote and market its products that dwarf competitors Berlitz, CBS-owned (NYSE: CBS ) Pimsleur, and Disney's (NYSE: DIS ) Publishing Worldwide. Yet despite the marketing push, Rosetta Stone has struggled to get revenue, with the loss of government contracts weighing on the company's sales and high prices deterring many would-be customers. The availability of low-priced alternatives from Disney and McGraw-Hill (NYSE: MHP ) make Rosetta Stone's high price points particularly difficult to sustain.
Where Rosetta Stone is missing out is in the big international market for language instruction. With worldwide interest in learning languages much higher than in the U.S., estimates put foreign spending on instruction at about 90% of the world's total. Yet Rosetta Stone still gets more than four-fifths of its sales from the relatively weak U.S. market.
Another potential win could come from college campuses. Last year, Rosetta Stone started a program with James Madison University to offer a semester of course credit for taking its Conversational Spanish program. With college students used to paying up for instruction, Rosetta Stone's price point wasn't as big an issue -- and the potential market is huge.
In any event, Rosetta Stone needs to start doing things differently if it wants to improve on its lackluster results recently. Tapping into big growth opportunities could be the right move for the stock to start moving toward perfection.
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.
Rosetta Stone isn't the perfect stock, but we've got some ideas you may like better. Let me invite you to learn about three smart long-term stock plays in the Fool's latest special report. It's yours for the taking and is absolutely free, but don't miss out -- click here and read it today.
Click here to add Rosetta Stone to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.