Is Digital River the Perfect Stock?

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 Digital River (Nasdaq: DRIV  ) 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 Digital River.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

6.0%

Fail

 

1-Year Revenue Growth > 12%

3.6%

Fail

Margins

Gross Margin > 35%

83.0%

Pass

 

Net Margin > 15%

4.7%

Fail

Balance Sheet

Debt to Equity < 50%

53.4%

Fail

 

Current Ratio > 1.3

3.10

Pass

Opportunities

Return on Equity > 15%

2.7%

Fail

Valuation

Normalized P/E < 20

50.95

Fail

Dividends

Current Yield > 2%

0%

Fail

 

5-Year Dividend Growth > 10%

0%

Fail

       
 

Total Score

 

2 out of 10

Source: S&P Capital IQ. Total score = number of passes.

With only two points, Digital River isn't giving shareholders smooth sailing. The company is in a reasonably strong niche but has some vulnerabilities that concern investors.

Digital River makes tools that help companies manage their e-commerce, marketing, and payments related to their online presence. With customers ranging from big companies Logitech (Nasdaq: LOGI  ) , Western Digital (NYSE: WDC  ) , and SanDisk (Nasdaq: SNDK  ) to tiny e-merchants, Digital River aims to provide a one-stop service for any business seeking to take advantage of the Internet. Another promising niche for Digital River has been digital distribution of software and games, which has opened up the door to clients including Adobe Systems (Nasdaq: ADBE  ) and Electronic Arts.

But things haven't gone perfectly for Digital River lately. It lost Symantec (Nasdaq: SYMC  ) as a customer in 2009 -- a loss that cost the company more than 20% of its revenue. Then last week, Digital River lost nearly 20% of its value when it issued a profit warning for the current quarter.

With shares now having fallen by half in just the past six months, further writedowns of analysts' growth projections could prompt even further losses. Moreover, with Microsoft (Nasdaq: MSFT  ) accounting for nearly a third of its revenue, some investors are concerned that Digital River's fortunes are too closely tied to those of the software giant.

Digital River still has the capacity to get close to perfect. To do so, though, it needs to add some stickiness to its business model, making its customers so dependent on its products that they can't leave. Once it does that, an economic recovery could go a long way toward bringing back growth and pushing Digital River downstream toward perfection.

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 Digital River to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

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."

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Logitech, Western Digital, and Microsoft. Motley Fool newsletter services have recommended buying shares of Microsoft, Adobe Systems, and Logitech; creating a bull call spread position in Microsoft; creating a diagonal call position in Adobe Systems; and writing covered calls in Logitech. 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.


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Comments from our Foolish Readers

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 April 10, 2012, at 5:52 PM, gopihoods wrote:

    This is the most stupid article i have seen in a while..no mention on valuation of the business & net cash in the balance sheet..EV is negative..so, an investor buys this stock, pays nothing for the operating business itself.

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