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 Cummins (NYS: CMI) 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 Cummins.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

7.4%

Fail

 

1-Year Revenue Growth > 12%

4.0%

Fail

Margins

Gross Margin > 35%

26.1%

Fail

 

Net Margin > 15%

10.2%

Fail

Balance Sheet

Debt to Equity < 50%

11.7%

Pass

 

Current Ratio > 1.3

2.15

Pass

Opportunities

Return on Equity > 15%

30.9%

Pass

Valuation

Normalized P/E < 20

13.27

Pass

Dividends

Current Yield > 2%

2.0%

Pass

 

5-Year Dividend Growth > 10%

33.9%

Pass

       
 

Total Score

 

6 out of 10

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

Since we looked at Cummins last year, the company has held onto the point it gained between 2010 and 2011, exchanging slower revenue growth for a higher dividend yield. The stock, though, has struggled to break even over the past year.

Cummins is best known for building engines for heavy industrial equipment, and as you'd expect, that's an extremely cyclical business. So when economic times are good, Cummins shines with the rest of the industrials, but lately, slowing global growth has led to some pullbacks. Caterpillar (NYS: CAT) warned of a slowdown in long-term-earnings growth recently, and last month, Cummins also cut its guidance and announced plans to cut costs through workforce reductions and other measures.

Yet Cummins has tried to distinguish itself with a number of innovative moves. Its long partnership with Westport Innovations (NAS: WPRT) to develop natural-gas-powered engines has become extremely valuable given the glut of low-priced natural gas. But Cummins has also moved out on its own to explore its own potential designs, while also working with Navistar (NYS: NAV) to supply engines that will help Navistar meet EPA guidelines.

In its most recent quarter, Cummins met expectations, and investors responded positively by pushing its share price higher. North American engine sales did well, but China and Brazil failed to deliver good results.

In the long run, for Cummins to improve, it needs nat-gas infrastructure from Clean Energy Fuels (NAS: CLNE) or other innovators to give its nat-gas engines a chance to operate efficiently. If that comes, then Cummins is well-poised to transform the engine-production industry.

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.

The movement toward alternative energy is gaining momentum, and both Cummins and Clean Energy Fuels are key pieces to the puzzle. Both are poised to make a big impact on an essential industry, but is Clean Energy Fuels a buy right now, or would you be better off waiting? Read all about the company in our brand-new report. Just click here to get started.

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

The article Has Cummins Become the Perfect Stock? originally appeared on Fool.com.

Fool contributor Dan Caplinger has no positions in the stocks mentioned above. The Motley Fool owns shares of Clean Energy Fuels, Cummins, and Westport Innovations. Motley Fool newsletter services recommend Clean Energy Fuels, Cummins, and Westport Innovations. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


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