Is Lam Research 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 Lam Research (NAS: LRCX) 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 Lam Research.

Factor

What We Want to See

Actual

Pass or Fail?

Growth5-Year Annual Revenue Growth > 15%14.5%Fail
 1-Year Revenue Growth > 12%51.7%Pass
MarginsGross Margin > 35%46.2%Pass
 Net Margin > 15%22.4%Pass
Balance SheetDebt to Equity < 50%29.9%Pass
 Current Ratio > 1.34.79Pass
OpportunitiesReturn on Equity > 15%34.2%Pass
ValuationNormalized P/E < 209.81Pass
DividendsCurrent Yield > 2%0.0%Fail
 5-Year Dividend Growth > 10%0.0%Fail
    
 Total Score 7 out of 10

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

With 7 points, Lam Research produces near-perfection for its investors. The company is in a promising growth industry, yet it trades at bargain levels.

Lam Research is a semiconductor capital equipment maker that produces the equipment chipmakers use to create integrated circuits. In its 2010 annual report, the company listed customers including Samsung, Taiwan Semiconductor (NYS: TSM) , and Toshiba. With the growth in electronic device, semiconductor manufacturing has shown some strong growth.

But the semiconductor business is cyclical, and late last year, some signs emerged that suggested that the entire sector would see a big decline in growth. Kulicke & Soffa (NAS: KLIC) announced that its fourth-quarter revenue would show a big drop sequentially, while one Wall Street analyst downgraded Lam Research along with peers KLA-Tencor (NAS: KLAC) and Applied Materials (NAS: AMAT) .

More recently, it appears the slowdown is real. Last month, Novellus Systems (NAS: NVLS) beat earnings estimates but gave gloomy guidance for the coming quarter. Lam shares fell in sympathy.

If a cyclical slowdown occurs, then a trailing P/E below 10 could grow back into the double digits in the coming quarters. But given Lam's financial strength, any temporary setback might well just give investors a good buying opportunity. Lam isn't perfect, but at this stage in the economic cycle, its shares look awfully attractive.

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 Lam Research 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. The Motley Fool owns shares of Applied Materials and Kulicke & Soffa Industries. 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 a disclosure policy.

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

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