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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 Dr. Reddy's Labs (NYSE: RDY ) 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 Dr. Reddy's Labs.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||11.1%||Fail|
|1-Year Revenue Growth > 12%||27.3%||Pass|
|Margins||Gross Margin > 35%||55.7%||Pass|
|Net Margin > 15%||15.7%||Pass|
|Balance Sheet||Debt to Equity < 50%||65.1%||Fail|
|Current Ratio > 1.3||1.10||Fail|
|Opportunities||Return on Equity > 15%||25.2%||Pass|
|Valuation||Normalized P/E < 20||24.64||Fail|
|Dividends||Current Yield > 2%||0.7%||Fail|
|5-Year Dividend Growth > 10%||35.1%||Pass|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Dr. Reddy's Labs last year, the company has picked up a point. Better margins and returns on equity are behind the move, although a weaker balance sheet raises some minor concerns.
Patent cliffs make most pharmaceutical companies scared out of their wits. But while expiring patents lead to falling revenue at original drug developers, they represent a huge opportunity for Dr. Reddy's, which produces generic versions of those drugs once they become available. And with major drugs from Pfizer (NYSE: PFE ) , Merck (NYSE: MRK ) , and many other major players coming off patent in the next few years, Dr. Reddy's won't face any shortage of new products to consider.
Of course, the generics business is crowded. Teva Pharmaceutical (Nasdaq: TEVA ) dwarfs Dr. Reddy's with about 10 times its revenue, although some of that comes from branded drugs like Copaxone that will eventually face their own patent cliffs. To differentiate itself, Dr. Reddy's made a 10-year partnership with GlaxoSmithKline (NYSE: GSK ) whereby Glaxo will distribute and sell drugs that Dr. Reddy's produces and ships.
Last year, the generics industry dodged a bullet when the Supreme Court ruled that generics-makers can't be sued for inadequate warning-label information because they're bound to provide the same information as their brand-name counterparts. But for Dr. Reddy's, its presence in the Indian pharmaceutical market gives it its own unique set of regulatory guidelines to consider.
Looking forward, Dr. Reddy's has its growth trajectory planned out. If it can boost its dividend and give shareholders a more reasonable valuation, then it could move much closer to perfection in the near future.
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 the best investments from the rest.
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