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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 iRobot (Nasdaq: IRBT ) 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 iRobot.
What We Want to See
Pass or Fail?
|Growth||5-year annual revenue growth > 15%||19.7%||Pass|
|1-year revenue growth > 12%||13.3%||Pass|
|Margins||Gross margin > 35%||39%||Pass|
|Net margin > 15%||7%||Fail|
|Balance sheet||Debt to equity < 50%||0%||Pass|
|Current ratio > 1.3||3.59||Pass|
|Opportunities||Return on equity > 15%||16.5%||Pass|
|Valuation||Normalized P/E < 20||35.33||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 & Poor's. Total score = number of passes.
With six points, iRobot is vacuuming up some good financials. The company's two very different businesses complement each other fairly well, although some storm clouds may be on the horizon.
iRobot uses its technology to create some very different products. On the home consumer side, the company's Roomba robot vacuum cleaner navigates its way across rooms to clean them without human assistance. But the company also applies its self-directing robots to defense applications such as bomb disposal. As such, the company has worked both with the U.S. military directly as well as through defense contractors such as Boeing (NYSE: BA ) and Lockheed Martin (NYSE: LMT ) .
The consumer uses for iRobot's technology have big growth potential. An open-source architecture the company is working on could help developers make software applications that can make the robots more useful. With compatibility with both Apple (Nasdaq: AAPL ) and Google (Nasdaq: GOOG ) operating systems, iRobot could benefit from the innovation of app developers to find new uses for its products.
Over the past couple of quarters, though, some warning signs have come up. In the first quarter of 2011, iRobot saw its free cash flow turn negative, with a big boost in inventory levels raising concerns for shareholders despite growth in sales and net income. Then last week, the company again reported excellent revenue and profit growth, but receivables spiked upward , and free cash flow remained negative.
iRobot is a fascinating company. If it can realize its full potential, it has a chance to reach perfection, but it has to make sure it keeps a handle on its finances first.
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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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.