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.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||5.5%||Fail|
|1-Year Revenue Growth > 12%||12.4%||Pass|
|Margins||Gross Margin > 35%||30.1%||Fail|
|Net Margin > 15%||8.5%||Fail|
|Balance Sheet||Debt to Equity < 50%||47.2%||Pass|
|Current Ratio > 1.3||1.65||Pass|
|Opportunities||Return on Equity > 15%||17.5%||Pass|
|Valuation||Normalized P/E < 20||14.92||Pass|
|Dividends||Current Yield > 2%||3.5%||Pass|
|5-Year Dividend Growth > 10%||12.4%||Pass|
|Total Score||7 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Eaton last year, the company has seen its score climb by two points. Better returns on equity and a much cheaper valuation earned Eaton extra points, but its share price decline of around 15% hasn't made shareholders very happy.
With its production of electrical, hydraulic, and drivetrain components and systems, Eaton is definitely tapped in to the global economy. When economic activity appears to be slowing down, as it did last summer, Eaton's prospects look gloomier.
Yet so far, the industry has held up pretty well. Illinois Tool Works (NYSE: ITW ) and Cooper Industries (NYSE: CBE ) both saw durability in their electrical businesses, and Eaton's strength in that niche has helped it get through what could have been a rough patch for the company. More recently, even as China and Europe have been obstacles to growth, Eaton was able to raise its full-year earnings forecast as its U.S. customers start to look healthier.
The push back to the U.S. is a trend that several of Eaton's industrial peers are following. Both Honeywell (NYSE: HON ) and Danaher (NYSE: DHR ) expect the U.S. to be a bastion of strength for them in the face of weaker sales abroad. If Eaton's direct competitors follow suit, it could make for a tougher environment for Eaton, but the company still has the industry presence to keep an edge.
For Eaton to keep improving, it needs to use its geographical diversification to maximize its profits and growth. If it can succeed with that, then Eaton may be able to maintain its march toward 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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