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 Mentor Graphics (Nasdaq: MENT) 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 Mentor Graphics.
|
Factor |
What We Want to See |
Actual |
Pass or Fail? |
|---|---|---|---|
| Growth | 5-Year Annual Revenue Growth > 15% | 2.0% | Fail |
| 1-Year Revenue Growth > 12% | 18.6% | Pass | |
| Margins | Gross Margin > 35% | 85.4% | Pass |
| Net Margin > 15% | 7.7% | Fail | |
| Balance Sheet | Debt to Equity < 50% | 26.7% | Pass |
| Current Ratio > 1.3 | 1.57 | Pass | |
| Opportunities | Return on Equity > 15% | 10.0% | Fail |
| Valuation | Normalized P/E < 20 | 28.69 | Fail |
| Dividends | Current Yield > 2% | 0% | Fail |
| 5-Year Dividend Growth > 10% | 0% | Fail | |
| Total Score | 4 out of 10 |
Source: S&P Capital IQ. Total score = number of passes.
With a score of four, Mentor Graphics doesn't test out without some bugs. The company has gotten some attention from major investors but has definitely seen some ups and downs in the past year.
Mentor has a long history of using computer-aided design for building electronics. By automating the design and testing of hardware and embedded software in electronic components and systems, the company hopes to reap the benefits of helping electronics manufacturers make products more efficiently. Mentor counts some well-known companies among its customers, including NVIDIA (Nasdaq: NVDA), NetLogic (Nasdaq: NETL), and a subsidiary of ARM Holdings (Nasdaq: ARMH).
Unfortunately, Mentor also has a long history of mediocre shareholder returns. Over the past 17 years, Mentor shares have barely broken even. That compares badly to rivals Cadence Design Systems (Nasdaq: CDNS) and Synopsys (Nasdaq: SNPS), both of which have had much better returns since 1984.
Those lackluster results were enough to attract the attention of activist investor Carl Icahn, who made an offer for Mentor earlier this year. Yet the company rebuffed Icahn, rejecting his bid of $17 per share. The stock trades well below that figure now, even after posting better-than-expected earnings late last week.
Mentor needs some general economic strength as well as better execution at the company level in order to improve its standing. If it can't accomplish that, it would be better off to give in to Icahn's advances and let shareholders escape with at least a modest buyout premium.
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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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 ."
