Has Rackspace Hosting Become 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 Rackspace Hosting (NYSE: RAX  ) 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 Rackspace Hosting.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 33.5% Pass
  1-Year Revenue Growth > 12% 31.8% Pass
Margins Gross Margin > 35% 70.2% Pass
  Net Margin > 15% 7.8% Fail
Balance Sheet Debt to Equity < 50% 21.5% Pass
  Current Ratio > 1.3 1.23 Fail
Opportunities Return on Equity > 15% 15% Pass
Valuation Normalized P/E < 20 73.84 Fail
Dividends Current Yield > 2% 0% Fail
  5-Year Dividend Growth > 10% 0% Fail
       
  Total Score   5 out of 10

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

Since we looked at Rackspace Hosting last year, the company has gained a point. Better returns on equity are behind the jump, even though the stock hasn't gone anywhere over the past year.

Rackspace is a big player in the hot cloud computing industry. With its coming OpenStack infrastructure, Rackspace tries to make it easy to design software for its open-source platform, marketing that as a competitive advantage over its rivals. Plenty of big customers have agreed that its approach makes sense.

But in its most recent quarter, Rackspace failed to meet earnings estimates. Although the miss was only by a penny, and revenue rose 31%, Rackspace's pricey valuation means that even the tiniest of disappointments can lead to a big move down for its stock. As Amazon.com (Nasdaq: AMZN  ) has reduced the prices for its Amazon Web Services, Rackspace faces more competitive pressure.

That pressure will come from several directions. On one hand, Amazon and Microsoft (Nasdaq: MSFT  ) are big-name providers that focus on proprietary services to help companies boost their cloud presence. More recently, Google (Nasdaq: GOOG  ) announced its entrance into the industry last month with its Compute Engine. Verizon's (NYSE: VZ  ) buyout of Terremark also puts it in the competitive framework. But Rackspace hopes that its "fanatical support" will be enough to keep customers coming back to it.

For Rackspace to improve, it needs to deliver on the promises its stock price is already making. Boosting profits will be essential in order for the stock to move closer to perfection in the years ahead.

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.

Rackspace Hosting may not be perfect, but we've got some other ideas you might like better. Let me invite you to learn about three smart long-term stock plays in the Fool's latest special report. It's yours for the taking and is absolutely free, but don't miss out -- click here and read it today.

Click here to add Rackspace Hosting to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Microsoft, Amazon.com, and Google. Motley Fool newsletter services have recommended buying shares of Rackspace Hosting, Microsoft, Google, and Amazon.com, as well as creating a bull call spread position in Microsoft. 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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  • Report this Comment On July 30, 2012, at 11:51 AM, wtsandman wrote:

    Hardly since they are going to miss their 2nd straight quarterly street targets and revenue goals.

  • Report this Comment On September 04, 2012, at 2:31 PM, superfoolstocks wrote:

    The stocks up 26% since this article, I'd say well done and thanks for being a fool Dan Caplinger! I took a chance after reading this and made about 13K profit, shares sold today, I'm skeptical about their long term sustainability but this was a great short term investment, I hope others had a chance to invest also!

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