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 Western Digital (NYS: WDC) 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 Western Digital.
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%
4 out of 10
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With four points, Western Digital doesn't store enough points for perfection. The hard drive maker may seem like it has outdated technology, but it's still going strong despite some weakness in computer shipments.
Looking at the world of technology today, you might think that Western Digital's days were numbered. With PC sales giving way to smartphones and tablets that use solid-state memory from companies like SanDisk (NYS: SNDK) and Micron (NAS: MU) , hard drives seem destined to be the early 21st century's equivalent of the buggy whip.
But that way of thinking ignores the reality of the global economy. According to Intel (NAS: INTC) , emerging markets are still thriving on largely unbranded computers that rely on the low-cost storage that hard drives from Western Digital and Seagate (NAS: STX) produce.
Earlier this year, concerns about a glut of hard drives from Seagate, Hitachi (NYS: HIT) , and Western Digital kept their stocks under pressure. But more recently, inventory levels have stabilized, suggesting that at least for now, the market is in better shape than it was at the beginning of 2011.
Eventually, if solid-state drive prices fall in line with hard drives, then Western Digital could be in trouble. But under current conditions, the company is in a strong position to benefit from emerging-market growth -- and has an attractively cheap valuation as well. Western Digital isn't perfect, but it could potentially produce nice returns for investors.
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.
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At the time thisarticle was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Western Digital and Intel and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of and creating a diagonal call position on Intel. 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 a disclosure policy.
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