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 NVIDIA (NASDAQ: NVDA ) 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 NVIDIA.
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 9
Since we looked at NVIDIA last year, the company has given back the point it gained from 2011 to 2012. Even a new dividend wasn't enough to outweigh falling net margins and returns on equity, and the stock has fallen more than 20% over the past year.
NVIDIA has made a huge transformation in its business, having diversified well beyond its roots as a graphics-chip maker for the PC industry to move into both professional solutions and consumer products. In particular, its Tegra mobile processor line has made huge inroads in the mobile market, with the company scoring places in Google's (NASDAQ: GOOG ) Nexus 7 and Microsoft's (NASDAQ: MSFT ) Surface RT tablets. The Surface hasn't performed as well as the Nexus, much to Microsoft's chagrin, but the boost to NVIDIA's reputation is significant from both placements.
NVIDIA also had a competitive advantage over rival mobile-chip maker Qualcomm (NASDAQ: QCOM ) for much of 2012, as supply problems at Taiwan Semiconductor (NYSE: TSM ) constrained its ability to manufacture chips using the 28-nanometer production process. That affected Qualcomm more than NVIDIA, because NVIDIA's Tegra 2 and Tegra 3 chips are built on 40-nanometer processes rather than the 28-nanometer that Qualcomm's processors rely on. But the new Tegra 4 is 28-nanometer-based, so Taiwan Semi will need to step up to help NVIDIA keep production levels up.
For NVIDIA to improve, it needs to build on these successes and defend its turf against Qualcomm and other rivals. Any signs of weakness, as we saw yesterday in the company's negative forecast for current-quarter sales, could further exacerbate the stock's declines.
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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