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 Cree 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 Cree.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

23.6%

Pass

 

1-year revenue growth > 12%

21.1%

Pass

Margins

Gross margin > 35%

36.3%

Pass

 

Net margin > 15%

4.5%

Fail

Balance sheet

Debt to equity < 50%

0%

Pass

 

Current ratio > 1.3

7.38

Pass

Opportunities

Return on equity > 15%

2.2%

Fail

Valuation

Normalized P/E < 20

142.70

Fail

Dividends

Current yield > 2%

0%

Fail

 

5-year dividend growth > 10%

0%

Fail

       
 

Total score

 

5 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Cree last year, the company has regained one of the two points it lost from 2011 to 2012, as revenue growth has been strong recently. The stock has done even better, soaring 80% over the past year.

As recently as last summer, Cree looked like it was stuck in the dark. Given the company's reliance on light-emitting diode-based lighting and other products, a highly competitive market and seasonal factors had left the stock with big losses. Since then, though, Cree has bounced back, with strong growth and new innovation that has helped it stand up to its rivals. For instance, last May, the company showed a prototype of a dimmable LED lamp that it built with partner Marvell Technology.

One challenge with LED lighting is that it has been prohibitively expensive. But Cree just announced last week that it would introduce a series of LED bulbs that will include a 40-watt replacement option below the $10 price point. That's still quite a bit above the corresponding costs for incandescent and even energy-efficient compact-fluorescent bulbs, but Cree was optimistic enough about the release to push up its revenue and earnings guidance for the current quarter.

Still, other companies are seeing the value of the LED industry. Both General Electric and Philips Electronics have introduced LED replacement bulbs in the past year. GE's extensive distribution network and reputation in the industry will give it a competitive edge over Cree and other smaller players. At the same time, Universal Display is trying to up-end the industry with its organic LED products, which offer even greater efficiency. The OLED leader has grown even more quickly than Cree, and it has managed to achieve more than double Cree's net margins with its premium products.

For Cree to improve, it needs to work on getting its margins and earnings up in order to support its lofty share price. If it can tap into the potential for energy savings from more efficient lighting, then Cree could continue to grow at its current pace and get ever-closer to perfection in the years ahead.

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.

Universal Display has a powerful patent portfolio behind OLEDs, a technology poised to dominate Cree's traditional LED technology in the displays of the future. Its leadership in the industry makes Universal Display an underappreciated way to play the enormous sales growth in tablets and smartphones. However, like any new technology, there are plenty of risks to Universal Display. Motley Fool analyst Evan Niu, CFA, has authored a new premium report that dives into reasons to buy the company as well as the challenges facing it. For access to this comprehensive report, simply click here now.

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

The article Has Cree Become the Perfect Stock? originally appeared on Fool.com.

Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Universal Display. The Motley Fool owns shares of General Electric and Universal Display. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.

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