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 Sonus Networks (NAS: SONS) 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 Sonus Networks.
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 9
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.
Since we looked at Sonus Networks last year, the company hasn't been able to improve on its three-point score. The stock has lost a third of its value as the voice-over-Internet-protocol and data networking equipment provider finds itself in a growth backwater.
Sonus provides subscriber-based network equipment to its customers. But because of its size, the stock has been vulnerable to swings in revenue from the timing of its orders. For instance, Sonus held up well after last year's second-quarter earnings announcement came in well below expectations, and shares surged after the company made up that shortfall in the following quarter.
But Sonus faces serious competition. Peer Broadsoft (NAS: BSFT) has seen similar declines in the past year, while Acme Packet (NAS: APKT) has fallen off a cliff, dropping 75% as its inevitable slowdown from its high-growth days has forced valuations lower. The companies are all small enough to have carved out niches against industry giants Cisco Systems (NAS: CSCO) and Juniper Networks (NYS: JNPR) , but they're not invulnerable to overall industry trends that have forced even Cisco to retrench and make efforts to streamline its business.
In its most recent quarter, Sonus disappointed investors with guidance that showed a continuing loss throughout 2012. Until the company figures out a way to become and stay consistently profitable, Sonus will struggle to improve much in its quest for 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 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 Cisco Systems. Motley Fool newsletter services have recommended buying shares of Acme Packet. 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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