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 GlaxoSmithKline (NYSE: GSK ) 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 GlaxoSmithKline.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||3.6%||Fail|
|1-Year Revenue Growth > 12%||(5.7%)||Fail|
|Margins||Gross Margin > 35%||73.8%||Pass|
|Net Margin > 15%||12%||Fail|
|Balance Sheet||Debt to Equity < 50%||183.2%||Fail|
|Current Ratio > 1.3||1.25||Fail|
|Opportunities||Return on Equity > 15%||37.6%||Pass|
|Valuation||Normalized P/E < 20||12.30||Pass|
|Dividends||Current Yield > 2%||4.7%||Pass|
|5-Year Dividend Growth > 10%||7.2%||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at GlaxoSmithKline last year, the pharma company has seen its score fall by a point. Continued balance sheet weakness was to blame for the drop, but some bigger concerns loom for Glaxo that should have an even bigger impact on its future.
Glaxo has seen its stock perform very well in the past year. Yet Glaxo faces the same patent-cliff woes that many of its peers do. It has blockbusters like asthma-treatment Advair and diabetes-drug Avandia losing patent protection before the end of this year. Moreover, Avandia already has seen a drop-off in sales after the discovery of serious side effects forced the company to pull it off the European market and face tough restrictions from the FDA on U.S. sales back in 2010.
The company is trying to focus on its most successful operations. To do so, it sold off 19 of its over-the-counter brands, including the well-known Nytol sleep aid. That slimming-down has been a popular theme in the industry, as Pfizer (NYSE: PFE ) sold its capsule-development business last year and has looked into potentially spinning off its nutritional and animal health division. Bristol-Myers Squibb (NYSE: BMY ) has already become more of a pure-play drug company with its sales and spinoff activity recently.
The big question is where Glaxo will get its future growth. Although it is the marketing partner for Human Genome Sciences' (Nasdaq: HGSI ) Benlysta lupus drug, which has no competition, the treatment hasn't produced the sales that some expected. Others have speculated that the company might expand its presence in the stem-cell research area by buying Geron's (Nasdaq: GERN ) stem-cell assets, now that the small biotech has decided to halt its own work in the area.
CEO Andrew Witty clearly believes that Glaxo's pipeline is solid, saying that the company could file for as many as 10 new products this year and expecting results from 30 phase 3 trials. But to reach perfection, Glaxo needs those trials to bear fruit. The shares already reflect some uncertainty, but Glaxo needs to move forward successfully in order to justify even their current valuation.
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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