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 Kenexa (NYSE: KNXA ) 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 Kenexa.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||15.9%||Pass|
|1-Year Revenue Growth > 12%||32.1%||Pass|
|Margins||Gross Margin > 35%||60.0%||Pass|
|Net Margin > 15%||(2.1%)||Fail|
|Balance Sheet||Debt to Equity < 50%||12.0%||Pass|
|Current Ratio > 1.3||1.21||Fail|
|Opportunities||Return on Equity > 15%||(2.9%)||Fail|
|Valuation||Normalized P/E < 20||NM||NM|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||4 out of 9|
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
Since we looked at Kenexa last year, the company has lost a point. A drop in current ratio explains the decline, but shareholders certainly aren't displeased with the company, as the stock has soared more than 70% in the past year.
Kenexa helps human resources departments manage their employee and recruitment prospect pools with software designed to track the procedures and documentation they need to follow. As you might expect, during the recession, when hiring was down, the company faced some substantial challenges. But just as Automatic Data Processing (Nasdaq: ADP ) and Paychex (Nasdaq: PAYX ) found ways to make money despite high unemployment rates, so too has Kenexa managed to capitalize on opportunities from the tough economic environment.
Recently, consolidation activity in the industry has continued. Oracle (Nasdaq: ORCL ) bought competitor Taleo for $1.9 billion earlier this year, with many analysts seeing it as a smart cloud play. Yet after peer Lawson Software was taken private, the move arguably leaves Kenexa as the top pure play in its particular HR software niche.
Meanwhile, though, Kenexa keeps generating sales growth. The company has built momentum throughout the year, and as the economy improves, it continues to add new partners and find business prospects.
For Kenexa to keep improving, though, it needs to work on becoming consistently profitable. If the company can get its costs under control, then it could rapidly move in the right direction toward 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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