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 McKesson (NYS: MCK) 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 McKesson.
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%
3 out of 10
Source: S&P Capital IQ. Total score = number of passes.
With only three points, McKesson is a long way from being a perfect stock. The drug distributor finds itself in a cutthroat competitive environment, having to make do with thin margins and make the most of its profit opportunities.
McKesson distributes pharmaceuticals at the wholesale level to hospitals and other health facilities, as well as retail outlets like mail-order pharmacies. Along with Cardinal Health (NYS: CAH) and AmerisourceBergen (NYS: ABC) , McKesson is part of a near-oligopoly in its industry.
Last year's health-care reform law brought a lot of uncertainty to the entire health-care sector. But McKesson should see sales increase if reform brings millions of newly insured patients onto the rolls. And just as pharmacy benefit managers like Medco Health Solutions (NYS: MHS) and CVS Caremark (NYS: CVS) stand to gain by having patients move to generic drugs to cut costs, so too can McKesson see enhanced profits from generics -- because as it turns out, margins on generics are actually higher than those on brand-name drugs for McKesson and its peers. As blockbuster drugs from big pharma companies like Pfizer (NYS: PFE) and Merck (NYS: MRK) see their patent protection expire, more generics will become available for McKesson.
One other area of potential growth for McKesson is in its technology division. The company is trying to improve access to electronic health records. Although that's a small part of the business right now, it could mushroom into much more if the company plays its cards right.
McKesson's numbers don't make it look much like a perfect stock, but slow growth and thin margins are just part of the reality of the industry. Where McKesson needs help, though, is with its dividend yield, which is slightly lower than AmerisourceBergen and only half what Cardinal pays. McKesson also has a slightly higher debt load than its peers. If it can get those factors under control, that'll go a long way toward making McKesson closer to perfection.
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 the best investments from the rest.
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At the time thisarticle was published
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