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 Elan Corporation, plc (ADR) NYSE:ELN) 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:
1). 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.
2). Margins. Higher sales mean nothing if a company can’t produce profits from them. Strong margins ensure that company can turn revenue into profit.
3). 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.
4). Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
5). 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.
6). 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 Elan, noting that in light of recent events which we’ll discuss below, all of these past financials are no longer indicative of the company’s future.
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Growth | 5-year annual revenue growth > 15% | 16.5% | Pass |
| 1-year revenue growth > 12% | 20.4% | Pass | |
| Margins | Gross margin > 35% | 47.7% | Pass |
| Net margin > 15% | 27.1%* | Pass | |
| Balance sheet | Debt to equity < 50% | 102.4% | Fail |
| Current ratio > 1.3 | 3.06 | Pass | |
| Opportunities | Return on equity > 15% | 46.7%* | Pass |
| Valuation | Normalized P/E < 20 | NM | NM |
| Dividends | Current yield > 2% | 0% | Fail |
| 5-year dividend growth > 10% | 0% | Fail | |
| Total score | 6 out of 9 |
Source: S&P Capital IQ. All figures based on trailing 12 months as of 2012 Q3 release. NM = not meaningful due to negative normalized GAAP earnings. Total score = number of passes. *Based on continuing operations as of 2012 Q3.
Since we looked at Elan last year, the company has gained a point, adding to the two points it jumped from 2011 to 2012. But the stock hasn’t responded positively, sinking by nearly 30% in the past year, and now, it faces a transformative event.
Elan is best known for its Tysabri drug, the multiple sclerosis treatment that it shared with Biogen Idec Inc. (NASDAQ:BIIB) . Yet in the biggest news for the company of the past year, Elan decided to sell out its 50% share of Tysabri rights to Biogen, taking $3.25 billion in upfront cash, as well as royalties of 12% during the first year and a tiered 18% to 25% royalty on sales in subsequent years. The move should help Biogen compete more effectively against MS rivals by allowing it to coordinate sales of Tysabri with fellow MS drug Avonex and its soon-to-be-approved BG-12 oral drug without worrying about cannibalizing its own revenue stream.
For Elan, though, the deal leaves the company with plenty of cash and no clear substantial revenue from continuing operations. Another drug to which Elan had retained financial rights, bapineuzumab, didn’t pan out when Johnson & Johnson (NYSE:JNJ) and Pfizer Inc. (NYSE:PFE) said in July that one of its late-stage trials didn’t show the drug was effective in treating Alzheimer’s. The company spun off its Prothena Corporation plc (NASDAQ:PRTA) drug discovery unit in December and recently sold off its shares of Alkermes Plc (NASDAQ:ALKS) that it obtained from selling off its drug technology unit, leaving it with a minimal pipeline.
The big question is what Elan will do with all of its cash. If it uses the money to buy back shares or pay dividends to shareholders, then the recent drop will be unwarranted. But if it wastes the money on ill-advised acquisitions, Elan could end up being worthless in the long run. In either event, Elan isn’t going to move toward perfection at all until it comes up with a viable business strategy for its future.
The article Has Elan Become the Perfect Stock? originally appeared on Fool.com and is written by Dan Caplinger.
Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson.
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