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 Nuance Communications (Nasdaq: NUAN ) 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 Nuance Communications.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||23.0%||Pass|
|1-Year Revenue Growth > 12%||22.9%||Pass|
|Margins||Gross Margin > 35%||67.0%||Pass|
|Net Margin > 15%||5.4%||Fail|
|Balance Sheet||Debt to Equity < 50%||54.1%||Fail|
|Current Ratio > 1.3||1.42||Pass|
|Opportunities||Return on Equity > 15%||3.3%||Fail|
|Valuation||Normalized P/E < 20||109.65||Fail|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Nuance Communications last year, the company has lost a point. Shares of the voice-recognition-software company have been all over the place but have still outperformed the market substantially over the past year.
Nuance is best known for being the company behind Siri, the voice-recognition system found on Apple's (Nasdaq: AAPL ) iPhone. The success of the iPhone 4S has helped boost Nuance's reputation, but the company also provides voice services to other customers, including US Airways (NYSE: LCC ) and its automated customer-service program.
But the company faces a huge threat from AT&T (NYSE: T ) , which has developed its own low-cost speech-recognition software. With the telecom giant having opened its doors to developers, it's entirely possible that Apple, Google, and Microsoft (Nasdaq: MSFT ) could turn to AT&T's voice-recognition services over time, cutting Nuance out of the loop.
So far, though, Nuance has seen impressive success. The company beat expectations for both sales and earnings in its most recent quarter, with strong margins coming from new efficiencies in its sales operations.
For Nuance to keep improving, a lot depends on what the coming iPhone 5 includes. If Siri continues to get better, then Nuance's stock could follow suit. For now, though, the shares are priced pretty much for perfection, leaving little room for Nuance to advance strongly.
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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