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 Rio Tinto (NYS: RIO) 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 Rio Tinto.
What We Want to See
Pass or Fail?
5-Year Annual Revenue Growth > 15%
1-Year Revenue Growth > 12%
Gross Margin > 35%
Net Margin > 15%
Debt to Equity < 50%
Current Ratio > 1.3
Return on Equity > 15%
Normalized P/E < 20
Current Yield > 2%
5-Year Dividend Growth > 10%
9 out of 10
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With an unusually high score of 9, Rio Tinto falls just short of perfection. With a dividend growth rate that comes a hair's breadth from breaking our 10% threshold, Rio wouldn't have to do much to get our first perfect 10.
As one of the world's largest producers of iron ore, Rio Tinto is just one of the companies that has profited handsomely from the huge boom in China. Competitors BHP Billiton (NYS: BHP) , Cliffs Natural Resources (NYS: CLF) , and Vale (NYS: VALE) are even more exposed to the emerging-market powerhouse than Rio is, and all of them rely heavily on continuing major infrastructure projects to create demand for the natural resources they produce.
Yet Rio mines more than just iron ore. It's also a significant copper producer, vying with Freeport-McMoRan Copper & Gold (NYS: FCX) and Southern Copper (NYS: SCCO) as well as BHP and Vale. That doesn't necessarily add much diversification to Rio's hoard, however, as copper is also economically sensitive and performs best in times when economies are strong.
Rio is positioning itself well for continued global growth. Just last week, the company raised $2 billion in debt financing at ultra-cheap interest rates, extending its debt load out as far as the year 2040. That gives Rio the flexibility it needs to take bigger gambles on long-term projects.
Rio's shares are cheap now as many expect the cyclical boom in China to subside and decimate earnings for the companies that have thrived on China's success. But even if short-term concerns drag down the stock, Rio looks like it could easily reach perfection if anything other than the worst-case scenario plays out for the emerging-market world.
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 the best investments from the rest.
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At the time thisarticle was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. 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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