Has Telefonica Become the Perfect Stock?

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 and then decide whether Telefonica (TEF 0.97%) 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.
• Moneymaking 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 Telefonica.

Source: S&P Capital IQ. NM = not meaningful; Telefonica suspended its dividend in 2012. Total score = number of passes.

Since we looked at Telefonica last year, the company has lost another point after falling by 2 points from 2011 to 2012. The stock has also suffered, falling 20% over the past year amid high levels of uncertainty in Spain.

Telefonica has gotten caught up in the European financial crisis, with slowdowns in consumer spending resulting from austerity measures across the eurozone and increased competition. In response, it suspended its dividend last year, going well beyond the dividend-trimming that France Telecom (ORAN 1.27%) did. Yet France Telecom has major international potential for growth in Africa and the Middle East, and Telefonica has a lucrative business in Latin America that is completely independent of Europe's woes.

But Telefonica is making moves to try to improve its service and attract new customers. A new partnership with key supplier Alcatel-Lucent (NYSE: ALU) involves a substantial purchase of 7950 XRS core network routers, which has the dual benefit of enhancing Alcatel's reputation as a telecom equipment company and giving Telefonica the increase in network capacity it needs to compete.

Moreover, Telefonica has taken steps to improve its internal operation. As unpopular as its dividend cut was, the move has helped Telefonica reduce debt. Also, even as competitor Vodafone (VOD 1.10%) gave up on early efforts to suspend smartphone subsidies to Spanish customers after losing 178,000 subscribers, Telefonica has stuck with its subsidy reductions and believes that they contributed to a big boost in operating income.

For Telefonica to improve, it needs the European economy to get back on its feet. Spain in particular has made substantial progress, but until the dividend comes back, Telefonica will have a tough time luring investors back to its shares.

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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