Is Eaton the Perfect Stock?

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 Eaton (NYSE: ETN  ) 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 Eaton.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 4.9% Fail
  1-Year Revenue Growth > 12% 18.5% Pass
Margins Gross Margin > 35% 30.1% Fail
  Net Margin > 15% 7.4% Fail
Balance Sheet Debt to Equity < 50% 44.1% Pass
  Current Ratio > 1.3 1.71 Pass
Opportunities Return on Equity > 15% 14.7% Fail
Valuation Normalized P/E < 20 21.84 Fail
Dividends Current Yield > 2% 2.7% Pass
  5-Year Dividend Growth > 10% 12.8% Pass
       
  Total Score   5 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

With a score of 5, Eaton finishes in the middle of our scale. The maker of industrial components has its hand in some interesting technologies, though, and could be poised to advance toward perfection if they pan out.

Eaton calls itself a diversified power management company, manufacturing a number of components that other companies use in their own products. For instance, the company supplies aerospace fuel, hydraulics, and pneumatic systems to airplane manufacturers like Boeing (NYSE: BA  ) , Airbus, and Embraer (NYSE: ERJ  ) .

But Eaton's electrical business dominates the rest of its segments, both in sales and operating profits. Eaton supplies customers of all sizes, ranging from established companies like Woodward (Nasdaq: WWD  ) to tiny innovator PowerSecure International (Nasdaq: POWR  ) with its electric-grid efficiency initiatives.

Eaton is also poised to benefit from building out an alternative-energy infrastructure, with a relationship with Clean Energy Fuels (Nasdaq: CLNE  ) . As natural-gas- and electric-powered vehicles become more commonplace, you'll likely find Eaton components in the fueling and charging networks that make them viable -- as long as the trend away from oil-based energy solutions continues.

With healthy and growing dividends, Eaton's shares may justify a somewhat lofty valuation. Although growth hasn't been as fast as investors would like to see, the future looks fairly bright for Eaton and may well bring better results for the company.

Keep searching
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.

Click here to add Eaton 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."

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Embraer. 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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