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 Pandora (NYS: P) 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 Pandora.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 112.3%* Pass
  1-Year Revenue Growth > 12% 111.2% Pass
Margins Gross Margin > 35% 40.1% Pass
  Net Margin > 15% (3.9%) Fail
Balance Sheet Debt to Equity < 50% 0% Pass
  Current Ratio > 1.3 2.57 Pass
Opportunities Return on Equity > 15% (12.5%) Fail
Valuation Normalized P/E < 20 NM NM
Dividends Current Yield > 2% 0% Fail
  5-Year Dividend Growth > 10% 0% Fail
       
  Total Score   5 out of 9

Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes. * Four-year growth rate.

With five points, Pandora comes in with a pretty strong signal. The Internet music company is newly public, but even though it hasn't historically turned a profit, it has many looking to a changing future for the music industry overall.

Pandora came public in mid-2011 to a great divide of opinion. Some pointed to the huge revenue growth that the company has enjoyed in recent years. Yet critics note that Pandora's costs to provide content increase as volume increases, meaning that the company doesn't get huge economies of scale to go with its growth. That puts it at a competitive disadvantage to Sirius XM Radio (NAS: SIRI) , which paid only about 15% of its gross revenue in royalties last year.

Still, Pandora is still growing quickly. Ford (NYS: F) was among the first to give car owners access to Pandora in vehicles, and General Motors (NYS: GM) and most other major car brands have followed suit. That puts more pressure on Sirius to hold onto what has traditionally been one of its strongest segments.

The real question for Pandora is what competitors do next. With everyone from Internet-based peers Spotify and iHeartRadio to CBS (NYS: CBS) and its last.fm going up against it, Pandora will be hard-pressed to maintain whatever moat it may enjoy.

For Pandora to get closer to perfection, it needs to establish its dominance in the industry and start making content deals that let it be more profitable. Otherwise, it will likely fall prey to the high costs that have killed many other companies in the past.

Keep searching
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.

Pandora may not be a perfect stock, but we've got some ideas you may like better. Let me invite you to learn about three smart long-term stock plays in the Fool's latest special report. It's yours for the taking and is absolutely free, but don't miss out -- click here and read it today.

Click here to add Pandora to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

At the time this article was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares of Ford and General Motors, as well as creating a synthetic long position in Ford. 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.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


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henselds

Sirius XM is superior in so many ways

March 08 2012 at 1:40 PM Report abuse rate up rate down Reply
elderayers

So..., I'm wanting them to play Holy Modal Rounders "If you want to be a bird.' Instead, they play something they think is "like" it. Well, crap! I'd rather program my own memory stick for...ZIP! And listen to Sirius for music, in neatly defined categories, I've listened to (and continue to expect) most of my life...for a very low monthly rate.

March 06 2012 at 10:40 PM Report abuse rate up rate down Reply