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 NetLogic (NAS: NETL) 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 NetLogic.
What We Want to See
Pass or Fail?
5-Year Annual Revenue Growth > 15%
1-Year Revenue Growth > 12%
Gross Margin > 35%
Net Margin > 15%
Debt to Equity < 50%
Current Ratio > 1.3
Return on Equity > 15%
Normalized P/E < 20
Current Yield > 2%
5-Year Dividend Growth > 10%
5 out of 10
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With a score of 5, NetLogic finishes in the middle of the road. But the network equipment maker got a nice boost from its industry leader's strong results.
NetLogic makes chips that help power high-speed networking equipment. With Verizon (NYS: VZ) and Vodafone (NAS: VOD) having rolled out their 4G network late last year through the jointly owned Verizon Wireless business and other wireless companies following suit, demand for NetLogic chips is extremely high.
Earlier this week, networking king Cisco Systems (NAS: CSCO) reported strong earnings, sending NetLogic shares higher as well. The news is good for NetLogic, since Cisco -- along with Alcatel-Lucent (NYS: ALU) and Huawei -- is a major NetLogic customer. Yet while Cisco is bargain-priced by just about every standard, NetLogic has a much more optimistic valuation -- and falling short could jeopardize the stock, as its recent slide suggests that investors fear. Moreover, being overly dependent on Cisco could spell trouble down the road if the tech giant doesn't keep up its growth pace.
NetLogic's problem, though, is a persistent lack of returns on equity. Even with its sky-high valuation, returns on equity have been negative on average for four years. Until the company can distinguish itself from a crowded chip space, NetLogic could find itself stuck in the doldrums in its quest to become a perfect stock.
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 NetLogic 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 thisarticle was published Fool contributorDan Caplingerdoesn't own shares of the companies mentioned in this article. The Fool owns shares of and has created a bull call spread position on Cisco Systems.Motley Fool newsletter serviceshave recommended buying shares of Vodafone Group and Cisco Systems. We Fools may not 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.