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 Cisco Systems (Nasdaq: CSCO ) 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 Cisco Systems.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||6.4%||Fail|
|1-Year Revenue Growth > 12%||6.3%||Fail|
|Margins||Gross Margin > 35%||61.8%||Pass|
|Net Margin > 15%||16.1%||Pass|
|Balance Sheet||Debt to Equity < 50%||31.9%||Pass|
|Current Ratio > 1.3||3.57||Pass|
|Opportunities||Return on Equity > 15%||14.9%||Fail|
|Valuation||Normalized P/E < 20||13.89||Pass|
|Dividends||Current Yield > 2%||1.9%||Fail|
|5-Year Dividend Growth > 10%||NM||NM|
|Total Score||5 out of 9|
Source: S&P Capital IQ. NM = not meaningful; Cisco paid its first dividend in March 2011. Total score = number of passes.
Since we looked at Cisco Systems last year, the networking giant has lost two points. Growth has slowed and returns on equity have fallen, but the stock sports a more attractive valuation than it did a year ago.
Cisco has had a tough couple of years. After building its reputation on providing the backbone of the Internet, Cisco started trying to diversify into other business lines. Yet after its foray into consumer products largely fell flat, Cisco found itself having to retrench and focus more on its core business -- despite competitors Juniper Networks (NYSE: JNPR ) and F5 Networks (Nasdaq: FFIV ) having made big inroads in the industry.
With Cisco's size, growth is a tough commodity to come by. But one of the growth areas that Cisco hopes to tap is the Internet television market. With Intel (Nasdaq: INTC ) , Google, Microsoft, and Apple (Nasdaq: AAPL ) all vying to try to create television services using various combinations of delivery platforms and set-top boxes, Cisco made its intent to join the group clear by buying pay-TV software company NDS earlier this year. Fool technology expert Eric Bleeker finds the move eerily reminiscent of past failures from Cisco, but the industry undeniably has huge potential if Cisco can find a way to tap it.
Still, conditions are tough right now. Yesterday, Cisco shares plunged more than 10% after the company gave poor guidance for the coming quarter. Cisco pointed to weakness in Europe and bad trends in enterprise spending as ominous signs for future sales.
For Cisco to get back on top, it needs to fend off its competitors and demonstrate its dominance of the networking space. That's a tall order, though, and so Cisco needs to accept the possibility that it may never become a perfect stock.
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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