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Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?
One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if International Paper (NYSE: IP ) fits the bill.
The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.
Some of the most basic yet important things to look for in a stock are:
- 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 don't mean anything if a company can't turn them into profits. Strong margins ensure that a company is able to turn revenue into profit.
- Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
- Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
- Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. 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?
|Growth||5-Year Annual Revenue Growth > 15%||0.1%||fail|
|1-Year Revenue Growth > 12%||(4%)||fail|
|Margins||Gross Margin > 35%||27.1%||fail|
|Net Margin > 15%||0.8%||fail|
|Balance Sheet||Debt to Equity < 50%||157.2%||fail|
|Current Ratio > 1.3||1.86||pass|
|Opportunities||Return on Equity > 15%||3.8%||fail|
|Valuation||Normalized P/E < 20||16.36||pass|
|Dividends||Current Yield > 2%||2.1%||pass|
|5-Year Dividend Growth > 10%||(27.5%)||fail|
|Total Score||3 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of just 3, International Paper doesn't look like the perfect stock. Despite its status as the top producer of paper and packaging products for consumer and industrial goods, the company has been plagued by troublesome economic trends.
Part of the problem comes from poor decisions. In 2008, International Paper spent $6 billion to make an acquisition from Weyerhaeuser (NYSE: WY ) and had to cut its dividend 90% in order to deal with the resulting debt. Debt is still a significant issue, especially with stagnant sales and razor-thin profit margins. Yet even competitor Domtar (NYSE: UFS ) , which has much better returns on equity and a healthier balance sheet, has suffered from slow revenue growth in the past few years.
In response, the company is trying to find new ways to position itself. One solution has been to address increasing demand for greener packaging solutions. Earlier this year, it created an eco-friendly lid for Green Mountain Coffee Roasters (Nasdaq: GMCR ) to match a similar cup it developed several years ago.
A turn in the economy should help International Paper's prospects. But in a highly competitive industry, the company will always have to work hard to maintain its leadership and turn its uncertain financial situation around.
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 out the best investments from the rest.
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