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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 FactSet Research Systems (NYSE: FDS ) 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 FactSet Research Systems.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||11.8%||Fail|
|1-Year Revenue Growth > 12%||12.4%||Pass|
|Margins||Gross Margin > 35%||66%||Pass|
|Net Margin > 15%||22.9%||Pass|
|Balance Sheet||Debt to Equity < 50%||0%||Pass|
|Current Ratio > 1.3||3.10||Pass|
|Opportunities||Return on Equity > 15%||32.5%||Pass|
|Valuation||Normalized P/E < 20||26.07||Fail|
|Dividends||Current Yield > 2%||1.3%||Fail|
|5-Year Dividend Growth > 10%||(2.1%)||Fail|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With six points, FactSet Research Systems puts up a good score. The gatherer of financial information has had a long history of strong growth, but a potential coming slowdown is making investors wonder if its valuation is too rich at current levels.
When professional investors look for information, they turn to data providers like FactSet for what they need. Just as Morningstar (Nasdaq: MORN ) focuses on mutual fund data and Bankrate (Nasdaq: RATE ) provides banking and credit-related information, FactSet seeks to combine its own proprietary databases with third-party data and other content from a variety of worldwide sources.
FactSet's services have the benefit of being fairly sticky. With a customer retention rate of more than 90%, once a customer goes with FactSet, it typically stays with the company.
The problem is that FactSet has plenty of competition stopping it from getting that business in the first place. McGraw-Hill's (NYSE: MHP ) S&P Capital IQ division brings a wide variety of business data and news to subscribers, while Thomson Reuters (NYSE: TRI ) has increasingly gone beyond simply providing news reporting to provide solutions that combine its own content with sophisticated technical information in areas like tax and accounting.
Earlier this week, FactSet disappointed investors with a weak outlook for the current quarter. Although it announced record revenue and better-than-expected earnings for the previous quarter, revenue growth is expected to grow by as little as 1% -- hardly the growth that can justify an expensive earnings multiple.
For FactSet to improve, it needs to focus on getting enough extra cash flow to boost its dividend. If earnings can also grow enough to reduce the stock's valuation, then FactSet will be a lot closer to perfection.
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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