Has Southwest Airlines 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, and then decide whether Southwest Airlines (LUV 2.60%) 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 the 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 Southwest Airlines.

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

Since we looked at Southwest Airlines last year, the company has quadrupled the one-point score it had in each of the past two years. Lower debt, faster dividend growth, and a cheaper valuation all contributed to the boost, but the stock has done well just to hold its altitude over the past year.

Southwest has long had a core following of fans who appreciate its open seating, discount philosophy, and joke-filled public announcements. With an emphasis on maintaining a reputation that sets it apart from its airline peers, Southwest has been able to mock Delta Air Lines (DAL 2.86%), United Continental Holdings (UAL 17.45%), US Airways (NYSE: LCC), and the other airlines that impose baggage fees, flight-change charges, and other fees that have raised the ire of passengers across the nation.

Southwest isn't just standing still, though. It recently placed orders with Boeing (BA -0.20%) for new 737MAX aircraft, spending $19 billion in order to boost fuel efficiency and modernize its fleet. The move keeps Southwest's one-model plane fleet intact but should help it cut expenses, especially on longer-range flights.

Even after taking over AirTran almost a year and a half ago, Southwest is still in the process of integrating its purchase. Earlier this week, the airline said it would transform existing AirTran routes in four cities into Southwest routes, with changes effective next spring.

In its most recent quarter, Southwest posted solid yet uninspiring results. With paying customer counts and revenue per passenger mile staying roughly flat, Southwest was able to eke out a modest profit. Fuel costs fell slightly, helping to boost the bottom line.

For Southwest to keep improving, the next logical step is to keep dividends moving upward while finding new ways to boost its balance-sheet strength. Given enough time, Southwest could get closer to perfection in the future.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfection than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate the best investments from the rest.

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