Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?
One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide whether Telefonica (NYSE: TEF ) fits the bill.
The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.
Some of the most basic yet important things to look for in a stock are:
- 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 don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
- Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
- Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
- Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. 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 Telefonica.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-Year Annual Revenue Growth > 15%||10.8%||fail|
|1-Year Revenue Growth > 12%||4.6%||fail|
|Margins||Gross Margin > 35%||57.0%||pass|
|Net Margin > 15%||18.6%||pass|
|Balance Sheet||Debt to Equity < 50%||272.7%||fail|
|Current Ratio > 1.3||0.61||fail|
|Opportunities||Return on Equity > 15%||56.7%||pass|
|Valuation||Normalized P/E < 20||12.00||pass|
|Dividends||Current Yield > 2%||7.6%||pass|
|5-Year Dividend Growth > 10%||36.9%||pass|
|Total Score||6 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Telefonica scores a respectable six points. But the true value of the Spanish telecom company comes from the irrational fear that investors have about European stocks in general.
Everyone knows the woes that Europe is going through right now. Yet even in a tough economic environment, Telefonica has managed to increase revenue overall.
Still, Europe remains a cutthroat-competitive market, with France Telecom (NYSE: FTE ) and Vodafone (NYSE: VOD ) among Telefonica's biggest rivals. However, Telefonica has an ace in the hole: its major presence in Latin America. A growing customer base and stable average revenue per user there have combined to give Telefonica its most attractive growth opportunity.
In addition, like U.S. telecoms AT&T (NYSE: T ) and Verizon (NYSE: VZ ) , Telefonica pays shareholders handsomely in the form of high dividend yields, which the company has increased at a quick pace in recent years.
Telefonica isn't a household name among U.S. investors, but it's a good example of how you can find strong dividend stocks with good growth prospects on international stock markets. It's not perfect, but Telefonica looks like it's making a lot of smart moves right now.
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.