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 Rio Tinto (NYSE: RIO ) 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 Rio Tinto.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||18.9%||Pass|
|1-Year Revenue Growth > 12%||(4.8%)||Fail|
|Margins||Gross Margin > 35%||35.4%||Pass|
|Net Margin > 15%||7.3%||Fail|
|Balance Sheet||Debt to Equity < 50%||32.3%||Pass|
|Current Ratio > 1.3||1.53||Pass|
|Opportunities||Return on Equity > 15%||7.1%||Fail|
|Valuation||Normalized P/E < 20||8.59||Pass|
|Dividends||Current Yield > 2%||2.7%||Pass|
|5-Year Dividend Growth > 10%||7.1%||Fail|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Rio Tinto last year, the company has dropped three full points. A drop in revenue, net margins, and returns on equity all dinged the miner's score, and contributed to the stock's 10% decline over the past year.
Rio Tinto is one of the largest mining companies in the world, and in recent years it has capitalized on the big increase in demand for iron ore, copper, and other metals from hungry emerging-market countries bent on improving infrastructure and supporting construction. Alongside rival BHP Billiton (NYSE: BHP ) , as well as Brazilian mining giant Vale (NYSE: VALE ) , Rio Tinto saw profits and sales rise over the years as the prices of its commodities have shot through the roof.
More recently, though, those favorable trends have dissipated. In its most recent earnings report, Rio Tinto announced a 13% drop in revenue and a 22% earnings decline. China's growth has slowed down, and economic woes in Europe and the U.S. have held back mining companies. Vale's stock in particular has lost a lot more ground than Rio, partially due to Brazil's weakening currency.
Rio Tinto is still upbeat, though. It believes that China will improve and is still planning to spend $16 billion on capital expenditures this year despite rising debt levels. The company also boosted its dividend, expressing its belief that cash flow easily will handle debt maintenance going forward.
This month, Rio has bounced back. Stimulus plans from China, Europe, and the U.S. have all increased optimism about the world economy. Copper miners Freeport-McMoRan (NYSE: FCX ) and Southern Copper (NYSE: SCCO ) have soared on recovery hopes, and with copper representing Rio Tinto's No. 2 product line, it too will benefit from higher copper prices if they result from the stimulative moves.
For Rio Tinto to improve, it needs to keep production levels high and hope for rising prices. If it gets lucky, Rio Tinto could be back near perfection in another year or two.
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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