Is Rackspace Hosting 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 Rackspace Hosting (NYSE: RAX  ) 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 Rackspace Hosting:

Factor What We Want to See Actual Pass or Fail?
Growth 5-Year Annual Revenue Growth > 15% 35.9% Pass
  1-Year Revenue Growth > 12% 27.7% Pass
Margins Gross Margin > 35% 69.1% Pass
  Net Margin > 15% 6.4% Fail
Balance Sheet Debt to Equity < 50% 27.1% Pass
  Current Ratio > 1.3 0.98 Fail
Opportunities Return on Equity > 15% 12.5% Fail
Valuation Normalized P/E < 20 87.96 Fail
Dividends Current Yield > 2% 0% Fail
  5-Year Dividend Growth > 10% 0% Fail
       
  Total Score   4 out of 10

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

With just four points, Rackspace Hosting can't boost its score into the clouds. But the company is still well-positioned to compete in the hot area of cloud computing.

As its name implies, Rackspace offers its hosting services to more than 150,000 companies, ranging from small businesses to huge outfits like Domino's Pizza. In a nutshell, as businesses move toward offering increasing numbers of applications and other software through the Internet, Rackspace helps them create the infrastructure they need to make that software work.

Rackspace is far from alone in the cloud business, though. Amazon.com (Nasdaq: AMZN  ) may be best-known as the Internet's largest retailer, but estimates put the company's cloud revenue at $650 million -- close to Rackspace's total 2010 revenue of around $780 million. Smaller 8x8 (Nasdaq: EGHT  ) offers hosting along with a suite of other Web-based services for small businesses. Even Verizon (NYSE: VZ  ) , with its purchase of Terremark earlier this year, has built a good-sized cloud business.

So far, though, Rackspace has posted impressive growth. Just last week, the company's second-quarter results showed revenue up 32% and income rising 62.5%, both beating expectations. That's a far cry from data-center operator Equinix (Nasdaq: EQIX  ) , which had to cut guidance late last year.

Rackspace stock is pricey without a doubt. But with its best growth still potentially ahead of it, Rackspace still has the potential to get much closer to perfection in the years to come.

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 Rackspace Hosting 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.

The Motley Fool owns shares of Domino's Pizza. Motley Fool newsletter services have recommended buying shares of Amazon.com and Rackspace Hosting. 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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