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 Pearson (NYS: PSO) 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 Pearson.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||8%||Fail|
|1-Year Revenue Growth > 12%||3.5%||Fail|
|Margins||Gross Margin > 35%||55.2%||Pass|
|Net Margin > 15%||16.3%||Pass|
|Balance Sheet||Debt to Equity < 50%||34.5%||Pass|
|Current Ratio > 1.3||1.83||Pass|
|Opportunities||Return on Equity > 15%||16.5%||Pass|
|Valuation||Normalized P/E < 20||19.59||Pass|
|Dividends||Current Yield > 2%||3.7%||Pass|
|5-Year Dividend Growth > 10%||7.5%||Fail|
|Total Score||7 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Pearson last year, the company's score has jumped by two points. A slightly lower stock price pulled valuations down, but the company also saw a nice boost to its return on equity.
Pearson is a publisher that has several focus areas. It's the company behind the Financial Times, and it has a mainstream consumer book publishing business, but many investors think of it primarily for its educational offerings of textbooks and class curricula, where it goes up against rival McGraw-Hill (NYS: MHP) .
The once-sleepy area of textbooks has actually been a center of digital innovation lately. With Amazon.com (NAS: AMZN) having started to offer rentals of e-book versions of textbooks last year, publishers Reed Elsevier and John Wiley & Sons (NYS: JW.A) quickly got onboard the Kindle-based program. As Apple's (NAS: AAPL) iPad and Barnes & Noble's Nook have joined the e-textbook market, they've seen increased sales as well. Apple in particular has chosen to focus not on college textbooks but rather on the K-12 market, where students typically have no choice but to use the textbooks that schools choose.
Despite the long-term inevitability of greater use of technology in publishing, Pearson hasn't yet seen a big bump to its growth. But new curriculum standards in the U.S. are forcing schools to change the way they teach math and English, and the demand for new and revised textbooks could prove to be a catalyst for Pearson.
Pearson needs that growth catalyst to pan out if it wants to become a perfect stock. But its solid dividend payout and healthy margins nevertheless make give Pearson a lot of potential going forward.
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 this article was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of McGraw-Hill, Apple, and Amazon.com. Motley Fool newsletter services have recommended buying shares of Apple and Amazon.com, as well as writing puts on Barnes & Noble and creating a bull call spread position in Apple. 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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