Has Ericsson 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 Ericsson (Nasdaq: ERIC  ) 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 Ericsson.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

3.7%

Fail

 

1-Year Revenue Growth > 12%

(0.7%)

Fail

Margins

Gross Margin > 35%

32.2%

Fail

 

Net Margin > 15%

6%

Fail

Balance Sheet

Debt to Equity < 50%

20.8%

Pass

 

Current Ratio > 1.3

2.11

Pass

Opportunities

Return on Equity > 15%

9.5%

Fail

Valuation

Normalized P/E < 20

29.86

Fail

Dividends

Current Yield > 2%

4.3%

Pass

 

5-Year Dividend Growth > 10%

(7.1%)

Fail

       
 

Total Score

 

3 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Ericsson last year, the company has seen its score cut in half. A drop in revenue combined with falling earnings and failing dividend growth cost Ericsson three points, and the stock has also disappointed investors with a roughly 20% loss over the past year.

Until this year, Ericsson had been the largest vendor of telecom equipment. But as a sign of the direction in which the industry has gone, Chinese giant Huawei took over the top spot from Ericsson over the summer months. Given how capital-intensive the telecom equipment industry is, some have questioned whether the recent weakness throughout the sector is indicative of a permanent shift against investors.

Ericsson's most recent quarterly results show the gulf in the telecom equipment industry right now. The company said that China, Korea, Russia, and parts of Europe were largely responsible for a 41% plunge in net income and a big drop in gross margins. Meanwhile, it said that North America was a relatively strong market at the moment. That points to continuing pain for Alcatel-Lucent (NYSE: ALU  ) and broad international reach, while U.S.-focused Ciena (Nasdaq: CIEN  ) and Sonus Networks (Nasdaq: SONS  ) stand to benefit if gains in the U.S. telecom equipment market pan out.

Still, Ericsson is making strides to support its growth. In an effort to help telecom companies conserve spectrum, Ericsson's base stations combine Wi-Fi and traditional cellular phone broadcasting, letting users use voice-over-IP services rather than tying up resources. Although the rival joint venture between Nokia (NYSE: NOK  ) and Siemens has come up with a different solution called Liquid Radio, Ericsson hasn't lost the fight just yet.

For Ericsson to improve, it needs to find the fastest-growing telecom markets and work on boosting equipment sales there. With increased competition, that's a tall order, but it's necessary if Ericsson wants to move back toward perfection.

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 the best investments from the rest.

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