Has L-3 Communications Become the Perfect Stock?

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 L-3 Communications (NYSE: LLL  ) 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 based on them. Strong margins ensure that a 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 L-3 Communications.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 3.3% Fail
  1-Year Revenue Growth > 12% (3.2%) Fail
Margins Gross Margin > 35% 10.9% Fail
  Net Margin > 15% 6.3% Fail
Balance Sheet Debt to Equity < 50% 60.5% Fail
  Current Ratio > 1.3 1.89 Pass
Opportunities Return on Equity > 15% 14.0% Fail
Valuation Normalized P/E < 20 8.30 Pass
Dividends Current Yield > 2% 2.8% Pass
  5-Year Dividend Growth > 10% 17.9% Pass
       
  Total Score   4 out of 10
Source: S&P Capital IQ. Total score = number of passes.


Since we looked at L-3 Communications last year, the company has kept its four-point score. But a loss of more than 10% in its stock over the past year has made the company look like an even bigger bargain.

There's no doubt that budget cuts at the Pentagon are having a big impact on defense-industry businesses. General Dynamics (NYSE: GD  ) reported a 3% drop in revenue during the first quarter of 2012, due largely to its exposure to government orders, and prospects look equally troubling for Lockheed Martin (NYSE: LMT  ) and Boeing (NYSE: BA,) in light of the possibility for even more defense cuts down the road.

But L-3 has some diversification across product lines that may eventually help wean it off its reliance on the U.S. military. With the company having spun off its Engility (NYSE: EGL  ) government-services subsidiary earlier this week, L-3 is left with more emphasis on its electronic systems and C3ISR divisions, both of which have held up reasonably well, thanks to foreign orders and greater demand.

Still, the huge uncertainty over the defense budget is taking a toll on prospects for the industry. With the Presidential election later this year, few analysts expect any decisive action on the budget front until next year at the earliest. Until then, defense stocks co uld be stuck in limbo waiting for future guidance.

To improve, L-3's best bet would be to keep working on other customers beyond the U.S. government to try to protect itself from budget cuts. That's a tough assignment for any company, but if L-3 can pull it off, it could make it that much easier to reach for perfection in the years ahead.

Keep searching
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.

L-3 Communications 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 L-3 Communications to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of General Dynamics, L-3 Communications, and Lockheed Martin. Motley Fool newsletter services have recommended buying shares of L-3 Communications. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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