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 Rock-Tenn (NYSE: RKT) 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 Rock-Tenn.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 30.3% Pass
  1-Year Revenue Growth > 12% 168% Pass
Margins Gross Margin > 35% 17.4% Fail
  Net Margin > 15% 1.9% Fail
Balance Sheet Debt to Equity < 50% 97.4% Fail
  Current Ratio > 1.3 1.54 Pass
Opportunities Return on Equity > 15% 7.2% Fail
Valuation Normalized P/E < 20 10.81 Pass
Dividends Current Yield > 2% 1.6% Fail
  5-Year Dividend Growth > 10% 16.7% Pass
       
  Total Score   5 out of 10

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

Since we looked at Rock-Tenn last year, the company has picked up two points. Despite an acquisition that boosted revenue strongly, the shares have dropped about 25% in the past year as returns on equity and margins took a big hit after the buyout.

Rock-Tenn's big sales growth comes from its $3.5 billion buyout of Smurfit-Stone Container last year. Although activist investor Dan Loeb and his Third Point investment company opposed the buyout, arguing that it didn't give Smurfit-Stone shareholders fair value, the merger went forward regardless, and now Rock-Tenn has been able to stay competitive in light of International Paper's (NYSE: IP) buyout of shipping-box maker Temple-Inland.

But Rock-Tenn hasn't yet turned the acquisition into huge profits. Its returns on equity lag behind both International Paper and peer Packaging Corp. of America (NYSE: PKG), and although Rock-Tenn has been closing several North American Smurfit-Stone plants to realize cost savings, it hasn't yet seen the full benefits from its merger that it expects to realize in the long run.

Another step Rock-Tenn is taking to cut costs is to hook into cheap natural gas. The company broke ground with TECO Energy (NYSE: TE) on a pipeline to deliver gas to a Rock-Tenn mill in Florida.

For Rock-Tenn to keep improving, it would definitely like to see continuing benefits from its Smurfit-Stone merger. With a challenging environment for forest products generally that has kept Weyerhaeuser (NYSE: WY) and other industry leaders from reaching their full potential, Rock-Tenn needs to make the most of its strengths to strive toward perfection in the future.

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.

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