Is Akamai the Perfect Stock?

Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Akamai Technologies (Nasdaq: AKAM  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • 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 don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. 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 Akamai.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 30.5% pass
  1-Year Revenue Growth > 12% 17.2% pass
Margins Gross Margin > 35% 73.1% pass
  Net Margin > 15% 16.2% pass
Balance Sheet Debt to Equity < 50% 2.9% pass
  Current Ratio > 1.3 4.25 pass
Opportunities Return on Equity > 15% 8.5% fail
Valuation Normalized P/E < 20 58.38 fail
Dividends Current Yield > 2% 0% fail
  5-Year Dividend Growth > 10% 0% fail
       
  Total Score   6 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

Akamai's score of six reflects its stellar growth past and extremely strong financial performance. Unfortunately, the stock is already priced for perfection, and it's unclear whether the company will be able to live up to the potential its investors see in it.

Admittedly, that potential is huge. Akamai helps Internet content providers make the most of limited bandwidth by optimizing where large files are stored, allowing transfers to happen more quickly and efficiently. It effectively solves traffic jams that would otherwise bring data movement to a screeching halt.

With all the innovation that has increased Web traffic, Akamai is making its presence known. It landed a high-profile contract from Netflix (Nasdaq: NFLX  ) , beating out competitors Limelight (Nasdaq: LLNW  ) and Level 3 (Nasdaq: LVLT  ) to help Netflix stream video to its subscribers. It also made a similar deal with privately held Brightcove, which works with Disney (NYSE: DIS  ) and other media companies to provide video services.

As long as demand remains high and business is booming, shareholders can't expect Akamai to divert valuable cash toward paying a dividend. Of more concern is the sky-high valuation and relatively weak returns on equity. To deliver on the promises its share price is making, Akamai not only needs to keep growing but also make that growth fall to the bottom line. If it does, the sky's the limit for the company.

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.

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

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Akamai Technologies is a Motley Fool Rule Breakers pick. Walt Disney and Netflix are Motley Fool Stock Advisor recommendations. Walt Disney is a Motley Fool Inside Value selection. Try any of our Foolish newsletters today, 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 Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (8)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 05, 2010, at 11:08 AM, netdragon wrote:

    "A similar deal with Brightcove"

    This isn't accurate. The deal with Brightcove wasn't exclusive and Brightcove is just adding Akamai as an available option within their video CMS platform, a position Limelight has already had for a while. So that means that Akamai can get a piece of the pie, but it doesn't mean that they are getting exclusive control of Brightcove space.

  • Report this Comment On November 05, 2010, at 1:16 PM, DanRayburn wrote:

    Akamai did not "beat out competitor Limelight" for the Netflix business. Akamai and Limelight both have them as a customer and Limelight is getting more of the business.

    In fact Limelight just announced yesterday that they have extend their contract with Netflix until 2013.

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