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 Western Digital (Nasdaq: WDC ) 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 Western Digital.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||17.9%||Pass|
|1-Year Revenue Growth > 12%||31%||Pass|
|Margins||Gross Margin > 35%||29.2%||Fail|
|Net Margin > 15%||12.9%||Fail|
|Balance Sheet||Debt to Equity < 50%||28.5%||Pass|
|Current Ratio > 1.3||1.77||Pass|
|Opportunities||Return on Equity > 15%||24.5%||Pass|
|Valuation||Normalized P/E < 20||7.98||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Western Digital last year, the company has picked up two points. The stock has done even better, rising more than 50% over the past year.
Western Digital has been through a lot in the last year. Last fall, the company suffered greatly as flooding in Thailand caused severe damage to its production facilities. By contrast, rival Seagate Technology (Nasdaq: STX ) wasn't hit nearly as hard, giving it a major competitive advantage over Western Digital.
Yet even though it took several quarters for Western Digital to catch up, it managed to bounce back a lot faster than many had thought. As early as January, Western Digital benefited from substantially higher prices from the much-reduced supply of hard drives, making up for production cuts and actually improving gross profits. The completion of its acquisition of Hitachi in March also eliminated a competitor.
Rising hard-drive prices, though, raised fears that solid-state drive makers STEC (Nasdaq: STEC ) and SanDisk (Nasdaq: SNDK ) would capitalize on a narrower cost differential. Certainly, some companies have made the switch, with Fusion-io (NYSE: FIO ) also capitalizing on the rising demand for solid-state technology. Yet hard drives remain much cheaper than their solid-state counterparts, and as demand for storage rises due to the cloud-computing trend, cheap storage options become even more important.
So far, recent results bear out Western Digital's continued strength. And at its current valuation, the stock could rally if anything better than a worst-case scenario pans out for the company. Improvement from wider margins is unlikely, but at some point, a dividend could serve to push Western Digital much 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.
Western Digital is just one American company that has reached around the world to dominate an industry. We've got three more promising stocks in the same position, and you can learn all about them in the Fool's special report, 3 American Companies Set to Dominate the World. Get your free copy today while it lasts.
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