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 Rockwell Collins (NYSE: COL ) 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 Rockwell Collins.
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With just five points, Rockwell Collins has some distance to cover if it wants to reach perfection. Unfortunately, questions about the defense industry have plagued the company, and as misguided as they may be, those pressures don't seem to be going away anytime soon.
Rockwell Collins makes electronic components for aviation and communications applications. Although the company has a commercial segment, its military sales account for most of its business -- about 60% of revenue and 65% of operating profit over the past 12 months.
The company stands out from its peers in generating strong internal returns on equity. Rockwell Collins handily outpaces both L-3 Communications (NYSE: LLL ) and Raytheon (NYSE: RTN ) on the communications front as well as General Dynamics (NYSE: GD ) in aviation. Perhaps because of those higher ROE figures, Rockwell Collins shares fetch a higher multiple than most of its defense peers.
The problem the whole industry faces is potential Pentagon budget cuts. Investors seem convinced that defense stocks generally will suffer greatly from newfound austerity in Washington, despite evidence to the contrary. If those fears don't pan out, then it may serve as a catalyst for Rockwell Collins to move a lot closer to perfection.
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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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.