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 Alexion Pharmaceuticals (Nasdaq: ALXN ) 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 Alexion Pharmaceuticals.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||161.1%||Pass|
|1-Year Revenue Growth > 12%||46.2%||Pass|
|Margins||Gross Margin > 35%||88.1%||Pass|
|Net Margin > 15%||22.5%||Pass|
|Balance Sheet||Debt to Equity < 50%||29.3%||Pass|
|Current Ratio > 1.3||2.30||Pass|
|Opportunities||Return on Equity > 15%||18.3%||Pass|
|Valuation||Normalized P/E < 20||109.85||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||7 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Alexion Pharmaceuticals last year, the company has picked up another point, as its return on equity has risen. Its sky-high valuation reflects a nearly 90% rise in the stock in the past year.
Alexion is unusual among small biotech companies because it already has an approved drug. Soliris, an orphan drug to treat a rare blood disorder, doesn't have a lot of patients who need it, but it's a lucrative treatment for the company. Like peers BioMarin Pharmaceutical (Nasdaq: BMRN ) and ViroPharma (Nasdaq: VPHM ) with their orphan drugs, Alexion is able to charge extremely high prices because the government often is willing to pay them.
But Alexion hasn't been content with its single success. The biotech bought three small companies in 2011, all of which have promising treatments in their pipelines. Although Alexion has had to dig into its cash balances and take on some debt, the long-term prospects look favorable.
Investors are extremely optimistic about Alexion's prospects. But the problem with high valuations is that they assume success even before it happens. For instance, Protalix BioTherapeutics (NYSE: PLX ) recently had its Elelyso drug for Gaucher Disease approved, but its shares didn't get a lasting pop out of the FDA approval.
Alexion isn't likely to build on its seven-point score anytime soon, as it needs capital for growth and will continue to have a premium valuation. In the long run, though, further successes could bring Alexion all the way 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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