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 NetApp (Nasdaq: NTAP ) 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 NetApp.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||17.3%||Pass|
|1-Year Revenue Growth > 12%||21.7%||Pass|
|Margins||Gross Margin > 35%||59.7%||Pass|
|Net Margin > 15%||9.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||29.5%||Pass|
|Current Ratio > 1.3||1.94||Pass|
|Opportunities||Return on Equity > 15%||15.1%||Pass|
|Valuation||Normalized P/E < 20||24.83||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at NetApp last year, the company has kept its six-point score. But with the shares having lost about 40% in the past year, the company clearly has some problems to fix.
As a data-storage specialist, NetApp is squarely in the middle of the big trend toward virtual and cloud computing. The company seemed to be poised for faster growth when it bought LSI's (NYSE: LSI ) external-storage division in April 2011.
But then the sector started slowing down quickly. Last summer, NetApp started seeing dramatically softer sales as government contracts and sales to financial institutions fell off. That slowdown has continued in the company's most recent quarter, leading to challenges not just for NetApp but also to supplier Xyratex (Nasdaq: XRTX ) , which produces some of the actual storage units that NetApp uses to provide its services.
Meanwhile, NetApp's competitors continue to make headway. Fusion-io (NYSE: FIO ) has grown quickly with its data decentralization products, putting both NetApp and rival EMC (NYSE: EMC ) in the difficult situation of fending off competition from a smaller player. Both EMC and NetApp have adopted flash-caching solutions in response, but they still seem to be on the defensive.
NetApp also found itself in a controversy when its email archiving products were found among tools an Italian contractor used to spy for the Syrian government. NetApp has denied that it knew about the sale, but it's still a black eye for NetApp.
For NetApp to improve, it needs to see an economic recovery take hold. Until macroeconomic conditions get better, businesses may not spend on IT fast enough to push NetApp 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.
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