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 (NYSE: 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?
|Growth||5-Year Annual Revenue Growth > 15%||9.3%||Fail|
|1-Year Revenue Growth > 12%||38.3%||Pass|
|Margins||Gross Margin > 35%||25.3%||Fail|
|Net Margin > 15%||9.6%||Fail|
|Balance Sheet||Debt to Equity < 50%||12.9%||Pass|
|Current Ratio > 1.3||1.88||Pass|
|Opportunities||Return on Equity > 15%||35.2%||Pass|
|Valuation||Normalized P/E < 20||13.15||Pass|
|Dividends||Current Yield > 2%||1.6%||Fail|
|5-Year Dividend Growth > 10%||30.4%||Pass|
|Total Score||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 (NYSE: NAV ) and Caterpillar (NYSE: 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 (Nasdaq: 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 (Nasdaq: 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.
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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."