Has Mentor Graphics 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 Mentor Graphics (MENT) 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 Mentor Graphics.

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

Since we looked at Mentor Graphics last year, the company has dropped a point, as its revenue growth slowed down considerably. The stock hasn't done nearly as badly, though, rising about 10% over the past year.

Mentor is one of the many companies that play a crucial role in the development of well-known electronic products. But Mentor doesn't make those products itself; rather, it helps provide software to help customers design and test the technology that goes into their products. In the past year, Core Logic (CLGX) started working with a Mentor subsidiary to optimize power use in its systems-on-chips, while IBM (IBM -1.38%) included Mentor's Capital tool suite as part of IBM's comprehensive project management environment, Rational Team Concert. Earlier this month, Mentor said that ON Semiconductor (NASDAQ: ONNN) used one of its products to boost productivity by 10 times.

Mentor has produced consistent positive results over the past year, beating analyst estimates for quarterly earnings for all four quarters. With the company due to report later this month, investors expect a 12% uptick in earnings per share on revenue gains of about 6%. Those numbers aren't terribly strong, but given the company's streak of double-digit-percentage surprises on the upside, Mentor likely has many investors hoping for better than current forecasts.

For Mentor to improve, it needs to start boosting its revenue more strongly than it has in the past. Rival Cadence Systems (CDNS 3.10%) has used acquisitions to bolster its sales, and Mentor could benefit from a similar strategy. With modest gains to returns on equity and a slight drop in earnings multiples, Mentor could easily be a couple points closer to perfection in the near future.

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.

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