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 TD AMERITRADE (AMTD) 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 TD AMERITRADE.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

4.9%

Fail
 

1-Year Revenue Growth > 12%

(4.3%)

Fail

Margins

Gross Margin > 35%

96.6%

Pass
 

Net Margin > 15%

22.4%

Pass

Balance Sheet

Debt to Equity < 50%

30.4%

Pass
 

Current Ratio > 1.3

1.16

Fail

Opportunities

Return on Equity > 15%

13.7%

Fail

Valuation

Normalized P/E < 20

15.15

Pass

Dividends

Current Yield > 2%

2.3%

Pass
 

5-Year Dividend Growth > 10%

NM

NM
       
 

Total Score

  

5 out of 9

Source: S&P Capital IQ. NM = not meaningful; TD AMERITRADE started paying a regular dividend in Nov. 2010. Total score = number of passes.

Since we looked at TD AMERITRADE last year, the company has held steady but not gained back any of what it lost from 2010 to 2011. The stock has also disappointed investors, falling almost 10% over the past year.

As a broker, TD AMERITRADE has had to deal with some pretty lousy conditions in the brokerage industry. With low interest rates, brokers don't earn as much interest on customer cash balances, and despite a strong stock market, retail investors still haven't returned to investing in the same volume as before the 2008 market meltdown. Yet the company pays a very attractive dividend, especially in comparison to the complete lack of payout that peer E*Trade Financial (ETFC) offers.

Still, strong competition has forced the company and its rivals to pay customers to come on board. Both TD AMERITRADE and E*Trade offer as much as $600 to new customers who open certain accounts with a minimum deposit. Schwab (SCHW -0.05%) and Fidelity have also resorted to cash rewards for new customers. Moreover, like Bank of America's (BAC -0.13%) Merrill Edge, TD AMERITRADE also gives you commission-free trading, although Merrill's offer goes beyond the initial trading period of TD AMERITRADE's free-trade policy.

More concerns about the industry arose after the Knight Capital Group (NYSE: KCG) trading debacle, in which Knight swallowed a huge loss after a trading glitch. With TD AMERITRADE having used Knight as a market-making counterparty, its disappearance would have been problematic, but Knight has rebounded substantially.

For TD AMERITRADE to improve, it needs retail customers to return to stock trading. Until that happens, and as long as interest rates remain low, it'll be hard for TD AMERITRADE to make much progress on becoming a perfect stock.

Keep searching
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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