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 VirnetX (AMEX: VHC) 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 VirnetX.


What We Want to See


Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% (21.8%)* Fail
  1-Year Revenue Growth > 12% (61.2%) Fail
Margins Gross Margin > 35% NM NM
  Net Margin > 15% NM NM
Balance Sheet Debt to Equity < 50% 0% Pass
  Current Ratio > 1.3 20.17 Pass
Opportunities Return on Equity > 15% (25.5%) Fail
Valuation Normalized P/E < 20 NM NM
Dividends Current Yield > 2% 0% Fail
  5-Year Dividend Growth > 10% 0% Fail
  Total Score   2 out of 7

Source: S&P Capital IQ. NM = not meaningful due to negative earnings and/or negligible revenue. Total score = number of passes. *4-year annual growth.

Since we looked at VirnetX last year, the company has seen its score drop significantly. A brief foray into profitability ended for the software company, and it now has to figure out which direction to go for its future.

VirnetX is a software company that specializes in online and mobile security. Having been created as a spin-out from defense contractor SAIC (NYSE: SAI), VirnetX started out with useful intellectual property from SAIC. With the huge growth in smartphone and tablet use, security issues promise to become ever more important in the coming years, and VirnetX hopes to capitalize on that trend.

So far, though, VirnetX has had its sole success come from defending its intellectual property. In 2010, Microsoft (Nasdaq: MSFT) paid the company $200 million to settle a patent infringement lawsuit. As more providers move toward 4G LTE networks, VirnetX hopes to license its technology to mobile players across the industry.

In the meantime, though, VirnetX has also gone after other alleged infringers. It argues that Apple (Nasdaq: AAPL) used VirnetX-patented VPN technology in its iPhone, iPad, and iPod touch devices. Meanwhile, the company's lawsuit against Cisco Systems (Nasdaq: CSCO) points toward voice-over-Internet products as well as routers with VPN capability.

Unless VirnetX can convince companies to make licensing deals absent litigation, its future seems reliant on its court cases. For now, investors need to expect huge volatility that's entirely driven by news about its infringement suits.

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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