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 Rambus (Nasdaq: RMBS ) 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 Rambus.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||9.6%||Fail|
|1-Year Revenue Growth > 12%||39.6%||Pass|
|Margins||Gross Margin > 35%||91.0%||Pass|
|Net Margin > 15%||(21.3%)||Fail|
|Balance Sheet||Debt to Equity < 50%||33.5%||Pass|
|Current Ratio > 1.3||4.09||Pass|
|Opportunities||Return on Equity > 15%||(17.8%)||Fail|
|Valuation||Normalized P/E < 20||41.44||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Rambus last year, the company has picked up an extra point, thanks to a jump in revenue. But with a 60% plunge in its shares over the past year, Rambus hasn't made its shareholders very happy.
Rambus has a fairly simple business strategy: It seeks to create new technological innovations and then license them to other companies. Rambus is best known for its memory chips, but it has been involved in other areas, including an agreement with General Electric (NYSE: GE ) to develop and improve LED lighting technology.
But Rambus has gotten a bad reputation from some analysts for its numerous patent lawsuits against industry peers. In its eight-year-long, $13 billion case against Micron Technology (Nasdaq: MU ) and Hynix, Rambus lost in a jury trial last November, although it has since appealed the decision. Similarly, LSI (NYSE: LSI ) and STMicroelectronics benefited when an International Trade Commission ruled against Rambus in a suit alleging patent infringement.
Rambus hasn't lost all of its cases. NVIDIA (Nasdaq: NVDA ) chose to settle a dispute with Rambus by signing a five-year licensing deal. But litigation expenses have gone a long way toward keeping the company from being profitable, as the company's positive normalized P/E above shows.
Rambus has started to draw attention from value-oriented analysts. But until the company figures out how to stay consistently profitable, it's hard to see how it will make much more progress 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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