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
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
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
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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