Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?
One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Microsoft (Nasdaq: MSFT) fits the bill.
The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.
Some of the most basic yet important things to look for in a stock are:
- 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 don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
- Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
- Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
- Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. 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 Microsoft.
|
Factor |
What We Want to See |
Actual |
Pass or Fail? |
|---|---|---|---|
| Growth | 5-Year Annual Revenue Growth > 15% | 10% | Fail |
| 1-Year Revenue Growth > 12% | 13.6% | Pass | |
| Margins | Gross Margin > 35% | 79.2% | Pass |
| Net Margin > 15% | 30.8% | Pass | |
| Balance Sheet | Debt to Equity < 50% | 20% | Pass |
| Current Ratio > 1.3 | 2.45 | Pass | |
| Opportunities | Return on Equity > 15% | 44.3% | Pass |
| Valuation | Normalized P/E < 20 | 13.04 | Pass |
| Dividends | Current Yield > 2% | 2.5% | Pass |
| 5-Year Dividend Growth > 10% | 7.2% | Fail | |
| Total Score | 8 out of 10 |
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Microsoft comes close to perfection with eight points. The company faces plenty of future challenges, but for now, the software giant continues to cash in on its dominant position in PC operating-system and business software.
Microsoft's Windows and Office software products have dominated the industry for a long time, and they make up a huge portion of the company's revenue. Between them, the two products made up almost 60% of Microsoft's sales in its 2010 fiscal year and were responsible for almost all of the company's operating profit.
The challenge Microsoft faces is to follow up those successes with future growth. Its Bing search engine has made only minor gains against Google's (Nasdaq: GOOG) leading position, and it lags behind Apple (Nasdaq: AAPL) and many others in mobile devices like smartphones and tablets. The company's recent partnership with Nokia (NYSE: NOK) to adopt the Windows Phone 7 platform in Nokia phones is an effort to make a difference in the space, but many see it as a desperation move on Nokia's part.
Things aren't all dire for Microsoft. Its Kinect system has been a huge success, selling 10 million units since its release. But given the company's huge size, it takes bold, broad-ranging initiatives to make a big difference to its bottom line.
Microsoft has done a great job of squeezing every dime from its landmark products. By itself, that's been good enough to bring it close to perfection, and if the company can find growth drivers going forward, that could be enough to get it to the top.
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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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our 13 Steps to Investing Foolishly.
