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 Level 3 Communications (LVLT) 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 Level 3 Communications.
Factor |
What We Want to See |
Actual |
Pass or Fail? |
---|---|---|---|
Growth |
5-year annual revenue growth > 15% |
8.4% |
Fail |
1-year revenue growth > 12% |
47.1% |
Pass |
|
Margins |
Gross margin > 35% |
59.2% |
Pass |
Net margin > 15% |
(6.6%) |
Fail |
|
Balance sheet |
Debt to equity < 50% |
750.5% |
Fail |
Current ratio > 1.3 |
1.02 |
Fail |
|
Opportunities |
Return on equity > 15% |
(35.7%) |
Fail |
Valuation |
Normalized P/E < 20 |
NM |
NM |
Dividends |
Current yield > 2% |
0% |
Fail |
5-year dividend growth > 10% |
0% |
Fail |
|
Total score |
2 out of 9 |
Since we looked at Level 3 Communications last year, the company hasn't been able to improve on its two-point score, as it has remained unprofitable. The stock has performed badly, falling nearly 20% over the past year.
With its dual focus on operating a fiber-optic network and acting as an Internet content-delivery service, Level 3 has suffered from big challenges on both sides of its business. Despite offering high-speed service, its network hasn't generated the cash flow that wireless network providers AT&T and Verizon have managed to produce. Meanwhile, on the content side, the decision that partner Netflix (NFLX 1.40%) made to move its traffic management in-house will cut the revenue Level 3 has received from its arrangement with the streaming video company.
In its most recent quarter, Level 3 disappointed investors with a weak earnings report. Although the company saw revenue rise slightly and said that its balance sheet has gotten stronger over the past year, Level 3 still posted a substantial loss for the fourth quarter. Expectations for seasonally weak sales in the current quarter also held back the stock.
The big hope for Level 3 is that a big acquirer might decide to buy out the company. With Google delivering high-speed service via its fiber-network experiment, Level 3's network might become more relevant. Yet with so much debt, Level 3's $12 billion enterprise value may prove a bit high for potential buyers despite arguably offering reasonable value.
For Level 3 to improve, it needs to find better sources of profitable sales. Unless it can do so, Level 3 is doomed to remain far from perfection for the foreseeable 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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