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 Level 3 Communications (NYSE:LVLT) 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 Level 3 Communications.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

8.4%

Fail

 

1-year revenue growth > 12%

47.1%

Pass

Margins

Gross margin > 35%

59.2%

Pass

 

Net margin > 15%

(6.6%)

Fail

Balance sheet

Debt to equity < 50%

750.5%

Fail

 

Current ratio > 1.3

1.02

Fail

Opportunities

Return on equity > 15%

(35.7%)

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 9

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

Since we looked at Level 3 Communications last year, the company hasn't been able to improve on its two-point score, as it has remained unprofitable. The stock has performed badly, falling nearly 20% over the past year.

With its dual focus on operating a fiber-optic network and acting as an Internet content-delivery service, Level 3 has suffered from big challenges on both sides of its business. Despite offering high-speed service, its network hasn't generated the cash flow that wireless network providers AT&T and Verizon have managed to produce. Meanwhile, on the content side, the decision that partner Netflix (NASDAQ:NFLX) made to move its traffic management in-house will cut the revenue Level 3 has received from its arrangement with the streaming video company.

In its most recent quarter, Level 3 disappointed investors with a weak earnings report. Although the company saw revenue rise slightly and said that its balance sheet has gotten stronger over the past year, Level 3 still posted a substantial loss for the fourth quarter. Expectations for seasonally weak sales in the current quarter also held back the stock.

The big hope for Level 3 is that a big acquirer might decide to buy out the company. With Google delivering high-speed service via its fiber-network experiment, Level 3's network might become more relevant. Yet with so much debt, Level 3's $12 billion enterprise value may prove a bit high for potential buyers despite arguably offering reasonable value.

For Level 3 to improve, it needs to find better sources of profitable sales. Unless it can do so, Level 3 is doomed to remain far from perfection for the foreseeable future.

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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