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 IBM (NYSE: IBM ) 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 IBM.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||2.3%||Fail|
|1-Year Revenue Growth > 12%||1.5%||Fail|
|Margins||Gross Margin > 35%||47.4%||Pass|
|Net Margin > 15%||15.3%||Pass|
|Balance Sheet||Debt to Equity < 50%||157.7%||Fail|
|Current Ratio > 1.3||1.22||Fail|
|Opportunities||Return on Equity > 15%||74.4%||Pass|
|Valuation||Normalized P/E < 20||16.77||Pass|
|Dividends||Current Yield > 2%||1.8%||Fail|
|5-Year Dividend Growth > 10%||19.0%||Pass|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at IBM last year, the company has picked up a point. Improving net margins gave the tech giant the boost, but the stock has mostly given investors market-matching performance over the past year.
IBM has continued to give investors the same slow and steady growth they've seen for years. Super-fast revenue growth is unlikely ever to return, but the company's three-pronged approach of getting in the door by selling hardware, and then following up with higher-margin software and consulting services, leads to impressive returns on equity and net margins. That model has been so successful that fellow tech giants Hewlett-Packard (NYSE: HPQ ) and Dell (Nasdaq: DELL ) are trying to do much the same thing to reinvigorate their business models.
One thing IBM has been doing extremely well lately is capital management. Yesterday, it sold $1 billion in 10-year bonds at the rock-bottom rate of 1 7/8%, a record low for 10-year corporate bonds. Demand for high quality bonds has been so strong that IBM can expect to see similar results for the foreseeable future, despite an uncomfortably high debt-to-equity ratio.
Moreover, IBM has taken steps to greatly boost its dividend. Following the same trend that has led Oracle (Nasdaq: ORCL ) and Cisco Systems (Nasdaq: CSCO ) to initiate dividends of their own in recent years, IBM has more than doubled its payout since early 2008 and has greatly accelerated its former payout growth.
For IBM to keep improving, getting its yield above 2% seems like the obvious next step. Any other measures to improve the company's score might actually be counterproductive for shareholders, so despite being nowhere near a perfect 10, IBM might be as close to perfect as it ever needs to get.
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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