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 Lam Research (Nasdaq: LRCX ) 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 Lam Research.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||0.8%||Fail|
|1-Year Revenue Growth > 12%||(17.7%)||Fail|
|Margins||Gross Margin > 35%||40.6%||Pass|
|Net Margin > 15%||6.3%||Fail|
|Balance Sheet||Debt to Equity < 50%||18.6%||Pass|
|Current Ratio > 1.3||3.09||Pass|
|Opportunities||Return on Equity > 15%||4.4%||Fail|
|Valuation||Normalized P/E < 20||34.35||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Lam Research last year, the company has lost four full points. Plunging revenue growth, margins, and profitability have pulled the stock well away from perfection, even though the shares have only dropped about 5% over the past year.
Lam Research makes equipment that companies use to manufacture semiconductor chips. This has gotten to be an increasingly large business, as chip demand has soared with the technology revolution.
However, as Fool tech analyst Brenton Flynn pointed out earlier this year, customer concentration has become an extremely challenging aspect of Lam's business. Competitors Applied Materials (Nasdaq: AMAT ) and KLA-Tencor (Nasdaq: KLAC ) share the problem, as the lion's share of all of their business comes from a select set of customers. While Applied Materials and KLA-Tencor count Intel (Nasdaq: INTC ) , Taiwan Semiconductor (NYSE: TSM ) , and Samsung as major customers, Lam is even more dedicated to Samsung, with Taiwan Semi and Toshiba also being important buyers. Those concentrations leave Lam vulnerable to margin contraction.
We've definitely seen signs of that vulnerability recently. In its most recent quarter, Lam Research fell short of analyst expectations, with a slight drop in revenue helping contribute to an 85% plunge in net income. Even worse, the company gave an outlook for the current quarter that was far worse than projected, sending shares plunging. Part of the damage came from accounting-related items connected to its Novellus buyout, but high costs and a weak overall environment were also factors.
For Lam to get back on the right track, it faces the big obstacle of becoming stronger than its rivals in the chip equipment space. That's a tall order, but without it, Lam doesn't have much chance of becoming a perfect stock in the near future.
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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