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 ARM Holdings (Nasdaq: ARMH ) 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 ARM Holdings.
What We Want to See
Pass or Fail?
|Growth||5-year annual revenue growth > 15%||11.8%||Fail|
|1-year revenue growth > 12%||33.3%||Pass|
|Margins||Gross margin > 35%||93.6%||Pass|
|Net margin > 15%||21.1%||Pass|
|Balance sheet||Debt to equity < 50%||0%||Pass|
|Current ratio > 1.3||2.42||Pass|
|Opportunities||Return on equity > 15%||10.5%||Fail|
|Valuation||Normalized P/E < 20||115.62||Fail|
|Dividends||Current yield > 2%||0.5%||Fail|
|5-year dividend growth > 10%||28.1%||Pass|
|Total Score||6 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
ARM Holdings scores a very respectable score of six. Its future, however, could become a lot brighter as the company makes big waves in a business dominated by some of the world's largest companies.
For years, two players have dominated the PC industry: Microsoft with its operating system software, and Intel (Nasdaq: INTC ) with its processors. With their chokehold over the computers that most people used, those two companies made life hard for also-rans such as Advanced Micro Devices (NYSE: AMD ) , which was relegated to making processors that piggybacked off Intel's instruction set, and other companies were unable to crack the processor market.
But recently, Microsoft announced that it's building a version of Windows that runs on platforms used by ARM Holdings' processors. As a result, ARM Holdings is challenging Intel not just for mobile devices but also in Intel's core PC market.
Meanwhile, the company has made serio us inroads in the booming mobile industry. ARM has made licensing deals with Broadcom (Nasdaq: BRCM ) to pair up on chipsets for low-cost smartphones for the global market, as well as seeking a place in higher-end devices from Apple (Nasdaq: AAPL ) and licensing deals to a group of major chip companies that includes stalwarts such as Texas Instruments (NYSE: TXN ) . Moreover, it has a vital partnership with IBM (NYSE: IBM ) helping ARM keep up with the latest technological innovations.
At more than 100 times normalized earnings, ARM isn't cheap. But if the company can stay on its current growth path, its financial performance could easily justify its current valuation. If you're willing to make a speculative play, ARM Holdings may be the perfect stock to do it with.
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 the best investments from the rest.
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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our 13 Steps to Investing Foolishly.