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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 Elan (NYSE: ELN ) 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 many 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 Elan.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||29.3%||pass|
|1-Year Revenue Growth > 12%||7.2%||fail|
|Margins||Gross Margin > 35%||50.3%||pass|
|Net Margin > 15%||(27.3%)||fail|
|Balance Sheet||Debt to Equity < 50%||513.2%||fail|
|Current Ratio > 1.3||2.69||pass|
|Opportunities||Return on Equity > 15%||(78.9%)||fail|
|Valuation||Normalized P/E < 20||NM||fail|
|Dividends||Current Yield > 2%||0%||fail|
|5-Year Dividend Growth > 10%||0%||fail|
|Total Score||3 out of 10|
Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful. Total score = number of passes.
With three points, Elan doesn't look like the perfect stock yet. Right now, the drugmaker is mostly a one-trick pony, but the future may have better things in store for Elan.
Right now, Elan gets the lion's share of its revenue from the multiple sclerosis drug Tysabri, which it shares with Biogen Idec (Nasdaq: BIIB ) . But even with that revenue, the company still hasn't managed to become cash-flow positive, let alone produce positive net income. That's the reason for the ugly net-margin and return-on-equity figures above.
Elan's future lies in its pipeline of Alzheimer's drugs. It's working with Pfizer (NYSE: PFE ) on bapineuzumab, and although Johnson & Johnson (NYSE: JNJ ) now controls half of Elan's half of the drug, the wide-open nature of Alzheimer's treatment has big potential. With the recent failure of Eli Lilly's (NYSE: LLY ) Alzheimer's drug semagacestat, whether Elan's drug will succeed remains uncertain, as the drug is now going through phase 3 trials.
Like many small drug companies, Elan is a risky proposition with the potential for huge rewards down the road. It doesn't look perfect now, but if it gets lucky with its drug pipeline, things will look up quickly for Elan.
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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