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 AOL (NYSE: AOL ) 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 AOL.
What We Want to See
Pass or Fail?
|Growth||5-year annual revenue growth > 15%||(20.7%)||Fail|
|1-year revenue growth > 12%||(3.8%)||Fail|
|Margins||Gross margin > 35%||27.8%||Fail|
|Net margin > 15%||46.7%||Pass|
|Balance sheet||Debt to equity < 50%||3.4%||Pass|
|Current ratio > 1.3||3.95||Pass|
|Opportunities||Return on equity > 15%||36.9%||Pass|
|Valuation||Normalized P/E < 20||22.59||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 AOL last year, the company has gained a point. Better returns on equity are behind the jump, which is partially why the stock has soared by more than 150% in the past year.
AOL is arguably best known for pioneering mass access to the Internet, first through its proprietary service and later with its search portal and home page. Yet the days of dial-up Internet access have mostly come and gone, and AOL has seen declining revenue as high-speed broadband from a variety of providers, including rural telecoms Frontier Communications (Nasdaq: FTR ) and Windstream (Nasdaq: WIN ) , have supplanted AOL's former leadership role.
But earlier this year, AOL managed to pique investor interest with a huge deal with Microsoft (Nasdaq: MSFT ) . In the deal, AOL sold more than 800 patents at a price exceeding $1 billion, which represented well over half of AOL's market cap at the time.
Still, some are skeptical about whether AOL is simply in a long process of liquidation. Its media acquisitions haven't resulted in the success that AOL had hoped to see, and its high share price puts its valuation well ahead of Yahoo! (Nasdaq: YHOO ) and Google.
For AOL to thrive, it needs to find a way to make its media offerings produce more money. Just as Yahoo! is trying to make the most of its plentiful content, AOL will continue to rely on monetizing its offerings through advertising. In a tough ad environment, it may take quite awhile for that strategy to pay off and push AOL any closer to 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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Also, Frontier Communications is just one player trying to profit from broadband Internet service. Will it beat the competition? Find out in the Fool's premium report on Frontier today.
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