Is CF Industries 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 CF Industries (NYSE: CF  ) 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 CF Industries.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 23.3% Pass
  1-Year Revenue Growth > 12% 73.7% Pass
Margins Gross Margin > 35% 44.8% Pass
  Net Margin > 15% 23.2% Pass
Balance Sheet Debt to Equity < 50% 34.1% Pass
  Current Ratio > 1.3 1.37 Pass
Opportunities Return on Equity > 15% 32.8% Pass
Valuation Normalized P/E < 20 7.35 Pass
Dividends Current Yield > 2% 1.1% Fail
  5-Year Dividend Growth > 10% 54.3% Pass
       
  Total Score   9 out of 10

Source: S&P Capital IQ. Total score = number of passes.

With nine points, CF Industries falls just short of perfection. The fertilizer company is at the forefront of a major macroeconomic trend that should give it tailwinds for years to come.

The fertilizer industry has had explosive growth over the past several years, as food inflation and increased demand from emerging-market countries have supported farmers and other agricultural businesses. That in turn makes farmers more able to afford fertilizer to improve crop yields. That has produced huge returns for companies like Mosaic (NYSE: MOS  ) and PotashCorp (NYSE: POT  ) , which focus on producing potash- and phosphate-based fertilizers.

The downside for Mosaic, PotashCorp, and other fertilizer companies like Intrepid Potash (NYSE: IPI  ) and Agrium (NYSE: AGU  ) is that they rely heavily on raw materials that they have to mine. By contrast, CF Industries primarily focuses on nitrogen-based fertilizers. Because obtaining nitrogen is as easy as collecting air (using natural gas to extract the nitrogen from it), CF has much lower capital expenditures -- leaving much more free cash flow at the end of the day for investors.

In addition, CF shareholders have the benefit of a roughly 75% stake in the master limited partnership Terra Nitrogen (NYSE: TNH  ) , which also makes nitrogen-based fertilizer. That produces even more cash flow in the form of dividends from Terra back to CF.

The danger for CF is that favorable conditions in agriculture won't necessarily last forever. Despite long-term macroeconomic trends, farming tends to be cyclical, and current valuations suggest that investors are battening down the hatches for the next downturn. But that also gives prospective shareholders an extra margin of safety -- one that makes CF an almost perfect stock for investors. In fact, based on yesterday's big plunge, I'm going to make my first pick on Motley Fool CAPS based on this article series and choose CF to outperform the S&P.

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 CF Industries 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. 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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