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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 Zimmer Holdings (NYSE: ZMH ) 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 Zimmer.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-year annual revenue growth > 15%||5.1%||Fail|
|1-year revenue growth > 12%||3%||Fail|
|Margins||Gross margin > 35%||76%||Pass|
|Net margin > 15%||14.1%||Fail|
|Balance sheet||Debt to equity < 50%||19.8%||Pass|
|Current ratio > 1.3||4.28||Pass|
|Opportunities||Return on equity > 15%||10.5%||Fail|
|Valuation||Normalized P/E < 20||17.80||Pass|
|Dividends||Current yield > 2%||0%||Fail|
|5-year dividend growth > 10%||0%||Fail|
|Total Score||4 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With a score of four, Zimmer isn't perfect. But the company is in a great place to capitalize on demographic trends, making the future look even brighter for shareholders.
Zimmer is a top maker of knee and hip replacements. Only a few competitors, including Stryker (NYSE: SYK ) , Smith & Nephew (NYSE: SNN ) , and Johnson & Johnson's (NYSE: JNJ ) DePuy division, go up against Zimmer in the area. But the industry has huge growth potential because of the aging U.S. population needing more of its products.
The problem with Zimmer is that it hasn't executed on the promise of its industry very well. It has the lowest return on equity of its peer group, and because both Stryker and Smith & Nephew have found ways to grow revenue faster than Zimmer, Zimmer has lost market share. And from a shareholder's perspective, Zimmer is the only company that doesn't pay a dividend. Yet despite its shortfalls, Zimmer doesn't trade at much of a valuation discount to its competitors.
Zimmer is in the right place at the right time. The question is whether it will capitalize on its potential. Unless the company can reverse its recent mistakes, Zimmer could very well find itself the odd one out in the joint replacement health care niche.
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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