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 Cummins (NYS: CMI) 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 Cummins.
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%
6 out of 10
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Cummins last year, the company has picked up an extra point. A big drop in valuations has brought Cummins another step closer to perfection.
Cummins is a pure play on production of engines, power generators, and exhaust systems. Unlike competitors Navistar (NYS: NAV) and Caterpillar (NYS: CAT) , which produce their own lines of vehicles to put engines in, Cummins merely provides engines for other makers. That gives Cummins a low debt-to-equity ratio that puts Caterpillar and Navistar to shame.
Just like PACCAR (NAS: PCAR) and its other competitors, Cummins continues to look to emerging markets for growth. It has expanded in Africa, Russia, and Indonesia, and also partnered with a Chinese company to build engines for the emerging nation. That has helped produce huge revenue growth in the past year, with its engine segment reporting a 43% jump in sales in the third quarter over year-ago levels.
Perhaps the most exciting venture at Cummins is its partnership with Westport Innovations (NAS: WPRT) to build natural-gas-powered engines. With huge conversion costs to switch a truck from diesel to natural gas, the new engine would save a lot of money -- and with diesel prices at high levels, the incentive is there for buyers.
Cummins would benefit greatly from a sustained uptick in the economy. Once questions about growth dissipate, Cummins is well placed to get even closer to a perfect showing -- and with a good dividend and low valuations, now's a good time for interested investors to get in.
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.
Click hereto add Cummins to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.
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."
At the time thisarticle was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. Motley Fool newsletter services have recommended buying shares of PACCAR, Westport Innovations, and Cummins. 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.
Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.