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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.
What We Want to See
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.
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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