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 Human Genome Sciences (Nasdaq: HGSI ) 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 Human Genome Sciences.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||40.0%||Pass|
|1-Year Revenue Growth > 12%||10.3%||Fail|
|Margins||Gross Margin > 35%||(83.0%)||Fail|
|Net Margin > 15%||(226.8%)||Fail|
|Balance Sheet||Debt to Equity < 50%||218.1%||Fail|
|Current Ratio > 1.3||1.97||Pass|
|Opportunities||Return on Equity > 15%||(81.6%)||Fail|
|Valuation||Normalized P/E < 20||NM||NM|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||2 out of 9|
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
With only two points, Human Genome Sciences hasn't quite cracked the code. Although the company was involved in the first approved treatment for lupus in 50 years, HGS hasn't yet seen the big jumps in sales and profits that many had hoped for.
Just over a year ago, HGS looked like it had just hit a home run. With the FDA approving its drug Benlysta to treat lupus, HGS investors bid up the stock to 64 times where it had traded in March 2009. Yet as happened to Dendreon (Nasdaq: DNDN ) and its cancer treatment Provenge, expectations got way ahead of reality. When HGS and marketing partner GlaxoSmithKline (NYSE: GSK ) weren't able to produce the stratospheric sales growth that the stock's sky-high valuation implied was inevitable, the stock gave back a lot of those gains.
Recently, HGS shares got so cheap that Glaxo offered to buy the company out at a premium to the then-depressed stock price. HGS rejected the $13 per share bid, and given the way the stock has traded, it seems unlikely that it will get a much higher price from a third party.
HGS also faces some potential competition. Anthera Pharmaceuticals (Nasdaq: ANTH ) has a potential lupus treatment in clinical trials, and with a recent failure with a treatment for acute coronary syndrome, Anthera might well turn more toward developing the lupus drug instead.
Things haven't gone HGS's way, and with substantial debt and horrific margins, it's unclear whether Benlysta can grow fast enough to get the company moving in the right direction. As painful as it will be for last year's investors, a buyout may be HGS's best chance at a strong future.
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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