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 American Water Works (NYSE: AWK) 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. Although 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 a 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.
  • Moneymaking 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 American Water Works.


What We Want to See


Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 5.0% Fail
  1-Year Revenue Growth > 12% 12.1% Pass
Margins Gross Margin > 35% 49.9% Pass
  Net Margin > 15% 10.3% Fail
Balance Sheet Debt to Equity < 50% 137.9% Fail
  Current Ratio > 1.3 1.15 Fail
Opportunities Return on Equity > 15% 6.9% Fail
Valuation Normalized P/E < 20 17.62 Pass
Dividends Current Yield > 2% 3.0% Pass
  5-Year Dividend Growth > 10% NM NM
  Total Score   4 out of 9

Source: Capital IQ, a division of Standard and Poor's. NM = not meaningful; American Water Works started paying a dividend in August 2008. Total score = number of passes.

A score of 4 doesn't make American Water Works a perfect stock. But the company has some attractive facets and is in an industry with huge growth potential.

American Water Works is a water utility with nationwide scope. Although the company mostly covers the eastern half of the U.S., it also operates in California, Arizona, and Washington, as well as the Canadian provinces of Manitoba and Ontario.

As fellow Fool Sean Williams recently discovered, American Water Works has some big advantages over the competition. It has one of the lowest price-to-book ratios in the industry, at roughly half the levels of Aqua America (NYSE: WTR) and York Water (Nasdaq: YORW). Yet even with its relatively slow revenue growth rate, the company is growing earnings faster than Connecticut Water Service (Nasdaq: CTWS) and American States Water (NYSE: AWR).

One concern, though, is the company's low return on equity. That's especially troublesome given American Water Works' high debt-to-equity ratio, which is greater than most of its competitors, including California Water Service (NYSE: CWT).

In the years ahead, water will increasingly play an important role in guiding growth, especially in drier parts of the West. With a reasonable valuation and strong dividend, American Water Works should keep you in the hunt to capitalize on those trends going forward.

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.

Add American Water Works to My Watchlist , which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our 13 Steps to Investing Foolishly.