Has Brocade Communications Become the Perfect Stock?

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 Brocade Communications (Nasdaq: BRCD  ) 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 Brocade Communications.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

14.9%

Fail

 

1-Year Revenue Growth > 12%

3.0%

Fail

Margins

Gross Margin > 35%

61.7%

Pass

 

Net Margin > 15%

6.2%

Fail

Balance Sheet

Debt to Equity < 50%

28.7%

Pass

 

Current Ratio > 1.3

1.79

Pass

Opportunities

Return on Equity > 15%

6.2%

Fail

Valuation

Normalized P/E < 20

19.95

Pass

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 Brocade Communications last year, the company hasn't been able to get back the point it lost between 2010 and 2011. Brocade's sluggish revenue growth has continued, even though it hasn't stopped the stock from picking up a healthy 35% gain over the past year.

Brocade is in the network infrastructure business, providing various hardware and related services to help client companies build and maintain networking solutions. With both direct relationships with clients as well as supply partnerships with IBM (NYSE: IBM  ) and Hewlett-Packard, among others, Brocade has kept its products in front of a wide variety of customers.

Brocade's business has been doing extremely well recently. In its most recent quarter, the company reported a 10% jump in sales that led to an even more impressive 59% rise in net income. Despite its expensive acquisition of Foundry Networks four years ago, Brocade has inspired optimism from investors despite its ongoing competitive fight against rival Cisco Systems (Nasdaq: CSCO  ) in the fiber-channel-over-Ethernet space.

One piece of uncertainty for Brocade comes from the future departure of CEO Mike Klayko, who said in August that he expects to leave the company as soon as its board of directors replaces him. Fool contributor Anders Bylund has raised the possibility that Klayko's exit could finally open the door for EMC (NYSE: EMC  ) or NetApp (Nasdaq: NTAP  ) to swoop in and buy the company in its entirety. But buyout rumors have plagued the stock for months without anyone actually putting money on the table.

For Brocade to improve, it needs to decide once and for all whether it's seeking a buyer. With a good history of innovation, the company could survive on its own, but you should likely wait for a disappointment-related pullback to take shape before picking up shares.

Keep searching
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.

Brocade is an interesting play, but Cisco Systems has a much bigger profile. Once a high-flying tech darling, Cisco is now on the radar of value-oriented dividend lovers. Get the low down on the routing juggernaut in our premium report, where you'll figure out whether Cisco is a buy. Our report also has you covered with a full year of free analyst updates to keep you informed as their story changes, so click here now to read more.

Click here to add Brocade Communications to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger has no positions in the stocks mentioned above. The Motley Fool owns shares of EMC and IBM. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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