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 VMware (NYSE: VMW) 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 VMware.

Factor What We Want to See Actual Pass or Fail?
Growth 5-Year Annual Revenue Growth > 15% 48.3% Pass
  1-Year Revenue Growth > 12% 40.3% Pass
Margins Gross Margin > 35% 82.6% Pass
  Net Margin > 15% 13.2% Fail
Balance Sheet Debt to Equity < 50% 11.3% Pass
  Current Ratio > 1.3 2.55 Pass
Opportunities Return on Equity > 15% 11.6% Fail
Valuation Normalized P/E < 20 140.63 Fail
Dividends Current Yield > 2% 0% Fail
  5-Year Dividend Growth > 10% 0% Fail
  Total Score   5 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

VMware finishes with a middle-of-the-road score of 5. The company finds itself in one of the highest-growth areas in the market, and it has the pricey valuation to match its potential.

VMware, which is itself majority-owned by EMC (NYSE: EMC), is a leader in the trend toward virtualization, in which companies increasingly choose to replace huge investments on a largely redundant technology infrastructure with shared computer resources that let large numbers of users in different locations gain access to the information and computing power they need. VMware provides the software that allows that to happen.

As more companies move to the cloud, VMware has seen stellar growth, both in its business and in its stock price. Yet as with any stock that trades at a high multiple to earnings, investors can get skittish. Earlier this year, the stock responded to a quarterly report of a 37% gain in revenue and doubling earnings by dropping 5%, leading some to believe that competitors like Red Hat (NYSE: RHT) and Citrix Systems (Nasdaq: CTXS) could threaten VMware's dominance of the space.

In its most recent quarter, though, VMware again beat analysts' expectations. As mobile devices make it impossible for technology users to carry all their data with them, comfort levels with cloud computing rise -- and VMware should continue to capitalize on that trend.

The bad news is that with a triple-digit normalized P/E, VMware pretty much has to capitalize if it wants to justify its share price. But naysayers have gotten burned by VMware thus far, and the company shows every sign of being able to continue its success well into the 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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