Has Scientific Games 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 and then decide whether Scientific Games (NASDAQ: SGMS  ) 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.
  • Moneymaking 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 Scientific Games.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

(1.6%)

Fail

 

1-year revenue growth > 12%

9.2%

Fail

Margins

Gross margin > 35%

43.5%

Pass

 

Net margin > 15%

(5%)

Fail

Balance sheet

Debt to equity < 50%

367.1%

Fail

 

Current ratio > 1.3

2.04

Pass

Opportunities

Return on equity > 15%

(10.8%)

Fail

Valuation

Normalized P/E < 20

85.86

Fail

Dividends

Current yield > 2%

0%

Fail

 

5-year dividend growth > 10%

0%

Fail

       
 

Total score

 

2 out of 10

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

Since we looked at Scientific Games last year, the company hasn't been able to improve its 2-point score. The stock also hasn't done well, posting about a 15% loss over the past year.

Scientific Games is the company behind the state lotteries that have made so many headlines with big jackpots. As a maker of lottery terminals and scratch-off lottery tickets, Scientific Games has arguably been in the right place at the right time, helping cash-starved state governments maximize the revenue potential of their lotteries. Yet the company hasn't been able to cash in itself, with disappointing results in its most recent quarter that included a big sales shortfall and a worse-than-expected loss that Scientific Games blamed on weakness in China.

Looking forward, an even bigger problem may be that Scientific Games hasn't kept up with all of the most promising trends in gaming. Rivals International Game Technology (NYSE: IGT  ) and Bally Technologies (NYSE: BYI  ) were awarded online gaming licenses by the state of Nevada earlier this year, giving them the inside track to the lucrative new market. To catch up, Scientific Games will need to make sure to stake its claim quickly if online gaming gets legalized at the federal level, all the while having to fend off heavy competition from both established gaming giant MGM Resorts (NYSE: MGM  ) as well as online social-gaming leader Zynga (NASDAQ: ZNGA  ) , both of which would benefit greatly from an expansion of their respective franchises.

In addition, some have questioned Scientific Games on governance issues. GMI Ratings singled out the company for issues on compensation, accounting, and its capital structure.

For Scientific Games to improve, it needs projects like its recent bid to run the Hellenic Lotteries in Greece to go well. Capitalizing on growth opportunities will be essential for the company to get its debt levels down and to become consistently profitable.

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.

To succeed online, Scientific Games will have to fend off Zynga's huge push toward online gaming. Given that Zynga's survival could well be on the line, the social-gaming company will be working hard to put itself in position. So does that mean investors should buy Zynga? Find out in our in-depth research report on the stock, in which we'll reveal what our top analysts have to say about Zynga. Don't buy the shares without reading it; click here to access your copy.

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


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