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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 Morningstar (Nasdaq: MORN ) 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 Morningstar.
What We Want to See
Pass or Fail?
|Growth||5-year annual revenue growth > 15%||13.5%||Fail|
|1-year revenue growth > 12%||10.6%||Fail|
|Margins||Gross margin > 35%||70.1%||Pass|
|Net margin > 15%||15%||Pass|
|Balance sheet||Debt to equity < 50%||0%||Pass|
|Current ratio > 1.3||2.31||Pass|
|Opportunities||Return on equity > 15%||11.4%||Fail|
|Valuation||Normalized P/E < 20||34.30||Fail|
|Dividends||Current yield > 2%||0.7%||Fail|
|5-year dividend growth > 10%||NM||NM|
|Total score||4 out of 9|
Source: S&P Capital IQ. NM = not meaningful; Morningstar started paying a dividend in Dec. 2010. Total score = number of passes.
Since we looked at Morningstar last year, the company has dropped two full points. Slowing revenue growth is responsible for the score loss, even though the stock has almost managed to break even in the past year.
Morningstar provides a variety of financial information to institutional and individual investors. Recently, the company has done a good job of building and retaining its institutional customers, especially with its Morningstar Direct product line, but attempts to build up more demand for advisory services as well as its own asset management through its managed portfolios.
But valuations in the financial information space have gone through the roof. Bankrate (Nasdaq: RATE ) trades at an even higher earnings multiple, while even Thomson Reuters (NYSE: TRI ) carries a normalized multiple above 20 despite its shares dropping 20% and posting a GAAP loss over the past 12 months. Meanwhile, Morningstar's margins have fallen, as a weak market environment has made the entire industry nervous.
Morningstar's best prospects come from moving into international markets. With demand for information higher on overseas investments, Morningstar can help facilitate the process with its research. With privately held Bloomberg and McGraw-Hill's (NYSE: MHP ) S&P Capital IQ as strong competitors, Morningstar needs to differentiate itself with a more practical focus.
To improve, Morningstar needs to get its margins back up and focus on bulking up growth. Unfortunately, as long as challenging markets persist, Morningstar will have trouble reaching 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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