Has Callaway Golf 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 Callaway Golf (MODG 1.14%) 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 Callaway Golf.

Source: S&P Capital IQ. NM = not meaningful because of negative earnings. Total score = number of passes.

Since we looked at Callaway Golf last year, the company has lost a point, as gross margins fell below our target benchmark. The stock has managed to rebound recently, though, rising about 10% over the past year.

Callaway has been in a downward trend for years, as the company never really recovered fully from the recession and market meltdown in 2008. Since then, the fall from grace of Tiger Woods has taken a lot of mainstream attention away from golf.

More recently, though, interest in golf seems to be on the rise again. The recent partnership of Tiger Woods and Rory McIlroy for Nike (NKE -0.48%) shows the willingness of big sports companies to spend big money on endorsement deals for the sport. Yet it also spells competition for Callaway, as Nike's powerful distribution network threatens Callaway's ability to sustain market share. Moreover, Under Armour (UAA 1.29%) is challenging Callaway in golf-related equipment and apparel, and Under Armour's increasingly close relationships with Dick's Sporting Goods (DKS -0.40%) and Foot Locker (FL 1.09%) to establish a store-within-a-store format should help it increase sales in the segment.

Still, one thing Callaway has going for it is a solid turnaround story. It's been slow, but analysts expect the company to get closer to breaking even in 2013 and then turn a decent profit next year. Admittedly, though, that's a long time to wait for profitability in a game where the fundamentals can change overnight.

For Callaway to improve, it needs to reach profitability and fend off competitors to build revenue back up. Unless it can succeed in doing so, it's unlikely to get out of the sand trap it's in, much less get closer to perfection anytime soon.

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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