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 Microsoft (Nasdaq: MSFT ) 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 Microsoft.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||9.4%||Fail|
|1-Year Revenue Growth > 12%||8.0%||Fail|
|Margins||Gross Margin > 35%||76.4%||Pass|
|Net Margin > 15%||32.6%||Pass|
|Balance Sheet||Debt to Equity < 50%||20.0%||Pass|
|Current Ratio > 1.3||2.86||Pass|
|Opportunities||Return on Equity > 15%||41.7%||Pass|
|Valuation||Normalized P/E < 20||16.06||Pass|
|Dividends||Current Yield > 2%||2.5%||Pass|
|5-Year Dividend Growth > 10%||13.6%||Pass|
|Total Score||8 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Microsoft last year, the software giant has kept its eight-point score. Lost in the shadow of its big competitor, Microsoft's 25% return on its shares over the past year is nothing to sneeze at.
Microsoft's stock has spent much of the past decade stagnating. Profits have rolled in thanks to its dominance in the PC operating system and office software market, but the company has missed out on becoming the industry leader in newer areas of tech expansion, most notably mobile devices.
But Microsoft is setting out to change that. The company's partnership with Nokia (NYSE: NOK ) is part of its plan to beat out Apple (Nasdaq: AAPL ) and Google (Nasdaq: GOOG ) in the huge Chinese market, as it introduced Windows Phone 7.5 in Beijing earlier this month. Apple's failure to make its phones compatible with the largest telecom player in China could give it an insurmountable competitive disadvantage, but Android-powered devices will be harder for Microsoft to pass up even with a low-cost strategy.
The key to Microsoft's future right now is its planned release of Windows 8 by this fall. With the ability to run devices that have either Intel (Nasdaq: INTC ) or ARM Holdings chips, Microsoft could see strong results in the holiday season -- assuming the release goes without any glitches. And with Intel ramping up its own mobile presence, hooking up with its PC partner could be a natural move.
Microsoft may never be able to regain the quick-growth pace that would give it its final points on our 10-point scale. But with a solid dividend, reasonable valuation, and some catalysts that could create new growth opportunities, Microsoft gives investors plenty of reasons to take a closer look.
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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