Is AOL the Perfect Stock?

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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 AOL (NYS: AOL) 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 AOL.

Factor

What We Want to See

Actual

Pass or Fail?

Growth5-Year Annual Revenue Growth > 15%(24.1%)Fail
 1-Year Revenue Growth > 12%(20.8%)Fail
MarginsGross Margin > 35%33.4%Fail
 Net Margin > 15%10.2%Fail
Balance SheetDebt to Equity < 50%5.2%Pass
 Current Ratio > 1.31.86Pass
OpportunitiesReturn on Equity > 15%10.6%Fail
ValuationNormalized P/E < 2010.38Pass
DividendsCurrent Yield > 2%0.0%Fail
 5-Year Dividend Growth > 10%0.0%Fail
    
 Total Score 3 out of 10

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

With a score of only 3, AOL isn't connecting well with perfection. The one-time online innovator has struggled to remain relevant in a much different world from its roots roughly 20 years ago.

Young investors may not remember when AOL was one of the only ways to gain access to the Internet, but the company was at the forefront of the online revolution. After huge successes in the 1990s, the company faded into relative obscurity as its business model went out of date.

Specifically, AOL's premium dial-up access became irrelevant as broadband access from telecoms like Verizon (NYS: VZ) and cable companies like Comcast (NAS: CMCSA) became affordable. Although peers United Online (NAS: UNTD) and Earthlink (NAS: ELNK) still provide similar service, AOL has seen its number of premium accounts fall by more than 85% to just 3.4 million households.

Now, the key to AOL's future success appears to lie in global advertising. The company's move to acquire Huffington Post and TechCrunch has helped it see its first gain in ad revenue in three years. Content production is far from a noncompetitive business, with everyone from the big search portals to Demand Media (NYS: DMD) using a similar business model.

The big question is whether AOL can use its brand recognition to stand out from the crowd of content providers. If so, then AOL could finally move back toward its perfection of the 1990s.

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.

Add AOL toMy Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our13 Steps to Investing Foolishly.

At the time this article was published Fool contributorDan Caplingerdoesn't own shares of the companies mentioned in this article. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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