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, Inc. (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.
