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 Zillow (Nasdaq: Z ) 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 Zillow.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||84.0%*||Pass|
|1-Year Revenue Growth > 12%||99.4%||Pass|
|Margins||Gross Margin > 35%||85.9%||Pass|
|Net Margin > 15%||3.8%||Fail|
|Balance Sheet||Debt to Equity < 50%||0%||Pass|
|Current Ratio > 1.3||3.93||Pass|
|Opportunities||Return on Equity > 15%||5.1%||Fail|
|Valuation||Normalized P/E < 20||506.05||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. *3.5 year growth rate.
With five points, Zillow ends up in the middle of the pack on our 10-point scale. But the stock has soared in the past year, rising almost 50%.
Zillow is the leader in the rapidly growing online real estate space. Despite having started with only a slight advantage over Move (Nasdaq: MOVE ) and Trulia back in 2009, Zillow's monthly unique-visitor count has tripled in that time frame, compared to much slower growth for its competitors. Although Move has a huge revenue advantage, Zillow is narrowing that gap quickly.
One way Zillow plans to grow is by going beyond a simple advertising model to offer more close-knit referrals between prospective buyers and real estate agents. Unlike Groupon (Nasdaq: GRPN ) , whose discounts generally haven't succeeded in creating customer loyalty, facilitating an initial relationship with a broker has huge value to the real estate industry.
Zillow is also using the rest of the Internet to its advantage. It locked up a deal with Yahoo! (Nasdaq: YHOO ) to sell real-estate agent advertising on its real estate page, and it worked with AOL (NYSE: AOL ) to display its daily "Mortgage Marketplace" rates, giving it valuable visibility.
Investors were disappointed earlier this month when Zillow decided to do a secondary share offering to raise capital. Yet despite the dilutive effect of the offering, it will give Zillow valuable cash at a time when it needs to invest in its business to get the most out of it.
For Zillow to keep improving, it will need to take its huge revenue growth and start looking to translate it into higher profits. For now, though, Zillow seems to be on the right path toward its long-term shot at 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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