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 Hewlett-Packard Company (NYSE:HPQ) fits the bill.
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:
1). 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.
2). Margins. Higher sales mean nothing if a company can’t produce profits from them. Strong margins ensure that company can turn revenue into profit.
3). 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.
4). Moneymaking opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
5). 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.
6). 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 Hewlett-Packard.
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Growth | 5-year annual revenue growth > 15% | 2% | Fail |
| 1-year revenue growth > 12% | (5%) | Fail | |
| Margins | Gross margin > 35% | 23.5% | Fail |
| Net margin > 15% | (10.9%) | Fail | |
| Balance sheet | Debt to equity < 50% | 121.2% | Fail |
| Current ratio > 1.3 | 1.12 | Fail | |
| Opportunities | Return on equity > 15% | (41%) | Fail |
| Valuation | Normalized P/E < 20 | 7.05* | Pass |
| Dividends | Current yield > 2% | 2.8% | Pass |
| 5-year dividend growth > 10% | 10.4% | Pass | |
| Total score | 3 out of 10 |
Source: S&P Capital IQ. Total score = number of passes.
*Normalized earnings exclude impact of goodwill impairments.
Since we looked at Hewlett-Packard last year, the company has gained a point. The combination of rising payouts and cheaper share prices earned the stock both dividend-related points, but investors still can’t be happy about the stock’s 30% drop over the past year. That downward move has held back the Dow Jones Industrials and its roughly 1,000-point gain over the same period.
HP is going through the same pains that many other PC-centric companies have faced recently, as it has suffered from weak PC sales and a failure to move decisively into the mobile-device market. For rival Dell Inc. (NASDAQ:DELL), the industry environment and investor sentiment has been so negative that the company is trying to go private, making Dell shareholders think twice about whether accepting the deal at a bargain-basement price really makes sense or whether the stock might do better if it remains public.
But HP is trying to make progress. By seeking to work with Google Inc (NASDAQ:GOOG) to release Android-operated devices, HP is trying to use Google’s strength in mobile as a way to bootstrap its struggling prospects. Google will also clearly benefit from HP’s decision to abandon Microsoft Corporation (NASDAQ:MSFT) and its Windows platform, which HP has relied on for years in its PC sales. Even with its woes, HP is a big enough player for the move to be meaningful for both Google and Microsoft.
Last Thursday night, Hewlett posted its most recent quarterly results, and the stock exploded higher by 12% the next day. It’s evident that CEO Meg Whitman’s attempts to cut costs have started to bear fruit, as the company’s bottom-line guidance was much higher than analysts were expecting. HP still has a lot further to go, but if optimistic guidance for the future proves correct, the shares are so cheap that there’s a lot more upside available for shareholders.
HP will find it hard to improve its score by these measures, as margins are hard to come by in the business, and its balance sheet needs time before it will heal. Still, value investors may find it a promising speculative play on a possible turnaround.
The article Has Hewlett-Packard Become the Perfect Stock? originally appeared on Fool.com and is written by Dan Caplinger.
Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Google and owns shares of Google and Microsoft.
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