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 Elan Corporation, plc (ADR) NYSE:ELN) 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:
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). Money-making 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 Elan, noting that in light of recent events which we’ll discuss below, all of these past financials are no longer indicative of the company’s future.
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Growth | 5-year annual revenue growth > 15% | 16.5% | Pass |
| 1-year revenue growth > 12% | 20.4% | Pass | |
| Margins | Gross margin > 35% | 47.7% | Pass |
| Net margin > 15% | 27.1%* | Pass | |
| Balance sheet | Debt to equity < 50% | 102.4% | Fail |
| Current ratio > 1.3 | 3.06 | Pass | |
| Opportunities | Return on equity > 15% | 46.7%* | Pass |
| Valuation | Normalized P/E < 20 | NM | NM |
| Dividends | Current yield > 2% | 0% | Fail |
| 5-year dividend growth > 10% | 0% | Fail | |
| Total score | 6 out of 9 |
Source: S&P Capital IQ. All figures based on trailing 12 months as of 2012 Q3 release. NM = not meaningful due to negative normalized GAAP earnings. Total score = number of passes. *Based on continuing operations as of 2012 Q3.
Since we looked at Elan last year, the company has gained a point, adding to the two points it jumped from 2011 to 2012. But the stock hasn’t responded positively, sinking by nearly 30% in the past year, and now, it faces a transformative event.
