Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Terra Nitrogen (NYSE: TNH) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • 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 don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. 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 Terra Nitrogen .

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

3.5%

fail

 

1-Year Revenue Growth > 12%

(37.8%)

fail

Margins

Gross Margin > 35%

32.3%

fail

 

Net Margin > 15%

29%

pass

Balance Sheet

Debt to Equity < 50%

0%

pass

 

Current Ratio > 1.3

6.12

pass

Opportunities

Return on Equity > 15%

71.6%

pass

Valuation

Normalized P/E < 20

20.83

fail

Dividends

Current Yield > 2%

9.7%

pass

 

5-Year Dividend Growth > 10%

21.9%

pass

       
 

Total Score

 

6 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

A score of 6 is reasonably good, even if it falls well short of perfect. In the fertilizer industry, potash producers Mosaic (NYSE: MOS) and PotashCorp (NYSE: POT) have gotten the lion's share of attention lately from investors, especially in light of BHP Billiton's (NYSE: BHP) bid to buy PotashCorp. But Terra Nitrogen focuses on a different niche, ammonia-based products, where it has strong pricing power.

Unfortunately, commodity prices plunged across the board when the recession hit, that's why revenue growth and gross margins have weakened from their 2008 levels. In addition, M&A activity in the industry has elevated share prices in recent months, making the stock less attractively valued. Because CF Industries (NYSE: CF) already owns 75% of Terra Nitrogen, a buyout isn't very likely. Terra Nitrogen pays a much higher dividend than CF, though, and has a lower multiple to earnings.

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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Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.