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 Ancestry.com (Nasdaq: ACOM ) 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 Ancestry.com.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||21.4%||Pass|
|1-Year Revenue Growth > 12%||35.9%||Pass|
|Margins||Gross Margin > 35%||83.4%||Pass|
|Net Margin > 15%||15.1%||Pass|
|Balance Sheet||Debt to Equity < 50%||0%||Pass|
|Current Ratio > 1.3||0.54||Fail|
|Opportunities||Return on Equity > 15%||17.1%||Pass|
|Valuation||Normalized P/E < 20||25.47||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With six points, Ancestry.com has put up a good history of promising financials. The company is still in its hyper-growth phase, but the challenge will be what it comes up with to sustain growth as it matures.
Ancestry.com provides a wide range of genealogical information and search tools for those seeking to learn more about their family trees. Although free search engines are competitors to an extent, Ancestry.com counts on its specialized tools being worth paying for -- and so far, plenty of subscribers have proven them correct.
But last summer, Ancestry.com dared to touch the third rail of paid-subscription sites: It bumped up its monthly rates while boosting discounts for longer-term subscriptions. By doing so, the company is trying to build the more reliable revenue streams that the subscription-based TiVo (Nasdaq: TIVO ) and Sirius XM Radio (Nasdaq: SIRI ) have -- even though Ancestry.com lacks the upfront hardware costs that tend to tie TiVo and Sirius XM customers to longer-term relationships. At the same time, Ancestry.com obviously wants to avoid the fate of Netflix (Nasdaq: NFLX ) , which made the mistake of counting too much on customers to pay a huge subscription-rate increase. Like Netflix, Ancestry.com has seen its shares plunge from their summer highs, but not to the same extent as the streaming giant.
Just yesterday, Ancestry.com announced some strong news. At the end of 2011, the company had more than 1.7 million paying subscribers, considerably above its previous guidance. Monthly churn rates also fell, showing that customers are sticking with the service longer.
For Ancestry.com to get closer to perfection, it needs to get to the point where it has enough cash on hand to keep its current ratio higher while also paying a dividend. In time, Ancestry.com should get to that point, even if it takes a while for it to reach that goal.
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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