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 Analog Devices (Nasdaq: ADI ) 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 Analog Devices.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||4.2%||Fail|
|1-Year Revenue Growth > 12%||(10.7%)||Fail|
|Margins||Gross Margin > 35%||64.6%||Pass|
|Net Margin > 15%||24.1%||Pass|
|Balance Sheet||Debt to Equity < 50%||20.9%||Pass|
|Current Ratio > 1.3||8.97||Pass|
|Opportunities||Return on Equity > 15%||16.9%||Pass|
|Valuation||Normalized P/E < 20||21.51||Fail|
|Dividends||Current Yield > 2%||3.0%||Pass|
|5-Year Dividend Growth > 10%||10.4%||Pass|
|Total Score||7 out of 10|
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
Since we looked at Analog Devices last year, the company has seen its score drop by two points. Falling revenue growth and a much higher valuation were responsible for the plunge, but shareholders have to be relatively pleased with the nearly 25% gain the stock has enjoyed in the past year.
Analog Devices makes integrated circuits for a wide range of applications. By converting light, sound, and other input to electrical signals, the company's devices allow electronic equipment to monitor and process the resulting data in ways that help their customers.
The key to understanding the semiconductor industry is that it's highly cyclical. Earlier this year, good news from Intel (Nasdaq: INTC ) and Texas Instruments (NYSE: TXN ) suggested that the industry might be in for another mini-cyclical bounce, as both companies posted some impressive results that included strong sales and stable demand. Analog Devices advanced strongly in response, and Qualcomm (Nasdaq: QCOM ) also looks favorably placed to take advantage of new industry growth.
But earlier this week, Analog Devices disappointed investors with drops in revenue and profit. Even worse, the company said that its fiscal fourth-quarter revenue and earnings will come in below expectations. That suggests that any mini-cyclical advance may have run its course, at least for Analog Devices.
For Analog Devices to improve, it needs to ride the next cyclical wave up to restore revenue growth. Otherwise, last year's nine-point showing may prove to be the closest that Analog Devices ever gets 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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