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 K12 (NYSE: LRN ) 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 K12.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||38.3%||Pass|
|1-Year Revenue Growth > 12%||38.1%||Pass|
|Margins||Gross Margin > 35%||41.1%||Pass|
|Net Margin > 15%||1.9%||Fail|
|Balance Sheet||Debt to Equity < 50%||7.4%||Pass|
|Current Ratio > 1.3||3.43||Pass|
|Opportunities||Return on Equity > 15%||2.7%||Fail|
|Valuation||Normalized P/E < 20||42.71||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at K12 last year, the company has kept its five-point score. Strong sales growth has continued, but margins and return on equity have remained weak, which is probably responsible for the stock having lost roughly 40% of its value in the past year.
For-profit education companies have taken a lot of criticism lately. Withdrawal rates at institutions ranging from Bridgepoint Education (NYSE: BPI ) to Apollo Group (Nasdaq: APOL ) and Corinthian Colleges (Nasdaq: COCO ) have been quite high, showing that many students aren't finishing their courses of instruction yet often rack up significant student loan debt in the process.
But like Chinese tutoring service New Oriental Education (NYSE: EDU ) , K12 hits at a different segment from for-profit colleges. With a focus on virtual learning for students in high school and younger, K12 is tied into government funding and doesn't have the specter of student loans to deal with. And like New Oriental, K12 tries to set the stage for continuing educational achievement in college and beyond.
Still, effectiveness is a concern. A New York Times article last December was critical of K12, noting that only a third of its online students were making adequate yearly progress on standardized testing. The company responded that many of the students that K12 serves are those particularly at risk of falling behind at their former schools.
For investors, an arguably bigger concern is that K12 has consistently failed to translate sales into profits. Early last month, the stock suffered a double-digit percentage loss after the company missed earnings estimates for the seventh straight quarter. Revenue growth is great, but at some point, it has to produce bottom-line results as well.
For K12 to improve, it needs to figure out a better way to monetize its services. Otherwise, it's likely to suffer from the same pressure its collegiate brethren have had to deal with for some time.
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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