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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 if Dr. Reddy's Labs (NYSE: RDY ) 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 Dr. Reddy's.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||27.1%||Pass|
|1-Year Revenue Growth > 12%||(3.7%)||Fail|
|Margins||Gross Margin > 35%||53.5%||Pass|
|Net Margin > 15%||13.2%||Fail|
|Balance Sheet||Debt to Equity < 50%||32%||Pass|
|Current Ratio > 1.3||1.28||Fail|
|Opportunities||Return on Equity > 15%||3.1%||Fail|
|Valuation||Normalized P/E < 20||36.85||Fail|
|Dividends||Current Yield > 2%||0.8%||Fail|
|5-Year Dividend Growth > 10%||35.1%||Pass|
|Total Score||4 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Dr. Reddy's scores just 4 points, leaving it well short of perfection. Competition in the generic drug industry is fierce, and the Indian drugmaker is finding itself getting left behind.
The pharmaceutical industry is a tough one to do business in. After spending years and huge amounts of money to develop new products, drugmakers only get a limited time to sell them exclusively. That's when generics companies like Dr. Reddy swoop in to make copycat versions of off-patent drugs at much cheaper prices. That's good for consumers, but has been giving Pfizer (NYSE: PFE ) , Merck, and other first-run drug companies fits as they contemplate their pipeline prospects. Pfizer has even decided to give up fighting and join the generics craze.
Generics overall have done well lately. But within the industry, Dr. Reddy's isn't keeping up with the competition. While Teva Pharmaceutical (Nasdaq: TEVA ) , Mylan (Nasdaq: MYL ) , and Watson Pharmaceuticals (NYSE: WPI ) have all seen growth continue in the past year, Dr. Reddy's has fallen behind with lower sales. Moreover, each of those competitors trades at a more attractive valuation while maintaining better internal returns.
With exposure to the Indian emerging market economy, Dr. Reddy's has an inside edge on one of the world's biggest growth markets. But it can't rest on its potential success. If Dr. Reddy reignites growth and gets its financial house in order, it could eventually become the perfect stock.
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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