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 Eli Lilly (NYSE: LLY ) 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 Eli Lilly.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||9.8%||Fail|
|1-Year Revenue Growth > 12%||7%||Fail|
|Margins||Gross Margin > 35%||79.6%||Pass|
|Net Margin > 15%||19.1%||Pass|
|Balance Sheet||Debt to Equity < 50%||47%||Pass|
|Current Ratio > 1.3||1.77||Pass|
|Opportunities||Return on Equity > 15%||33.9%||Pass|
|Valuation||Normalized P/E < 20||10.10||Pass|
|Dividends||Current Yield > 2%||5.4%||Pass|
|5-Year Dividend Growth > 10%||4.4%||Fail|
|Total Score||7 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Eli Lilly last year, the drugmaker has eked out an extra point. A slight reduction in its debt level was enough to get Lilly to a score of seven, and even though its sales growth falls short of our targets, it's fairly reasonable for a large company.
Lilly faces the same challenges as rivals Merck (NYSE: MRK ) and Pfizer (NYSE: PFE ) : the need to keep developing new drugs to replace existing blockbusters that are losing their patent protection. With Lilly losing Zyprexa, Cymbalta, and Humalog within the next couple of years, it's facing a lot of uncertainty right now.
Lilly does have some good candidates, though. Its evacetrapib cholesterol drug recently released some good trial results. Although the company lags behind Merck, Roche, and Amarin (Nasdaq: AMRN ) in cholesterol fighters, Lilly could still benefit, given the huge size of the market.
However, the battlefield to make good partnerships with smaller companies is fierce. Recently, Lilly broke off its marketing relationship with Amylin Pharmaceuticals (Nasdaq: AMLN ) over the Byetta injectable diabetes drug. Lilly will receive upfront payments and a royalty, but it could mean Lilly misses out if the drug -- or its offshoot, Bydureon -- becomes a big seller.
The reason Lilly offers such an attractive yield and cheap valuation is that investors aren't sure it can keep up its past success. But with a healthier balance sheet, Lilly has put itself in position to pick up promising drugs from upstart companies, potentially giving it the boost it needs to stand up to the competition.
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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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."