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 International Paper (NYS: IP) 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 International Paper.
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%
4 out of 10
Source: S&P Capital IQ. Total score = number of passes.
When we looked at International Paper last year, it only managed to score three points. Since then, the company's dividend yield has nearly doubled, revenue growth has returned, margins have recovered, and returns on equity have more than quadrupled to give the company an extra point.
International Paper's biggest news in the past year has been its buyout of shipping-box maker Temple-Inland (NYS: TIN) . IP expects the combination to produce big annual benefits of around $300 million fairly quickly, pushing the company's share of that market up to 37%. With Rock-Tenn (NYS: RKT) having bought out competitor Smurfit-Stone and AbitibiBowater (NYS: ABH) thought to be a potential target itself, IP's move makes sense given the competitive landscape.
The threat to IP, however, may eventually come from rising timber prices. Having sold huge amounts of its forest-land holdings in a restructuring several years ago, IP no longer gets the benefit that timber-heavy companies like Weyerhaeuser (NYS: WY) , Plum Creek Timber (NYS: PCL) , and Potlatch (NYS: PCH) get from a strong timber market -- and in fact, higher prices could raise costs for raw materials, threatening margins. Recently, the weak housing market has put a lid on timber prices, but that may not last forever.
For IP to achieve perfection, it needs a strong economy to bolster demand for paper and packaging, along with continuing improvement to the company's balance sheet and sales growth. Once that comes, International Paper could see its score rise substantially.
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. The Motley Fool owns shares of Rock-Tenn and Plum Creek Timber. 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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