Is Shutterfly the Perfect Stock?

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 Shutterfly (Nasdaq: SFLY  ) 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 Shutterfly.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-year annual revenue growth > 15% 30.7% Pass 1-year revenue growth > 12% 37.8% Pass Margins Gross margin > 35% 53.4% Pass Net margin > 15% 3% Fail Balance sheet Debt to equity < 50% 0% Pass Current ratio > 1.3 3.00 Pass Opportunities Return on equity > 15% 2.8% 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 because of negative normalized earnings. Total score = number of passes.

With a score of five, Shutterfly lands right in the center of the picture. But despite having a timely business for the season, the company faces some big competitive threats.

With the move to digital photography, photo processing has taken on an entirely new meaning. While film-focused companies like Eastman Kodak (N! YSE: EK< /span>  ) haven't successfully made the transition, Shutterfly seeks to fill a vital niche by helping its customers take their online pictures to produce physical prints, with an emphasis on creating holiday cards, birth announcements, and similar products.

Shutterfly has burst onto the scene with strong revenue growth that puts it in the same class as giants Amazon.com, priceline.com (Nasdaq: PCLN  ) , and Netflix (Nasdaq: NFLX  ) . But unlike those other three companies, Shutterfly hasn't been able to translate sales into equally strong earnings growth. With returns on capital languishing at low-single-digit levels, the company is suffering from the low-margin nature of the business, especially as customers coming in from daily deal sites like Groupon (Nasdaq: GRPN  ) have reportedly not produced big profits.

Competitive concerns have recently arisen about Shutterfly. Shares fell sharply yesterday after one analyst pointed to competition from Hewlett-Packard's (NYSE: HPQ  ) Snapfish as cutting into Shutterfly's profits. Following on the heels of an announcement last month that Apple (Nasdaq: AAPL  ) would release an app letting users design their own greeting cards, it's clear that Shutterfly won't be able to claim this entire industry for itself.

The next year should be an interesting one for Shutterfly. If it can fend off the competition and find ways to boost margins, then it could finally get earnings moving as fast as sales. If not, though, the stock could be a lot further from perfection in the future.

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 lon! g way to ward improving your investing prowess and learning how to separate out the best investments from the rest.

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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."