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 Pentair 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 Pentair.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

6.1%

Fail

 

1-year revenue growth > 12%

27.8%

Pass

Margins

Gross margin > 35%

28.7%

Fail

 

Net margin > 15%

(2.4%)

Fail

Balance sheet

Debt to equity < 50%

37.9%

Pass

 

Current ratio > 1.3

2.12

Pass

Opportunities

Return on equity > 15%

(2.5%)

Fail

Valuation

Normalized P/E < 20

145.53

Fail

Dividends

Current yield > 2%

1.8%

Fail

 

5-year dividend growth > 10%

8.0%

Fail

       
 

Total score

 

3 out of 10

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

Since we looked at Pentair last year, the company has gained a point, as its debt-to-equity ratio fell below the 50% mark. The stock has also managed to gain some ground, rising about 10% over the past year.

Water treatment has become an increasingly important part of the economy. As populations have grown in areas where water is scarce, Pentair has helped provide important filtration products to ensure water quality and efficiency.

About a year ago, Pentair took a big step forward, as it combined forces with the flow-control business of Tyco . Since then, the combined Pentair has sought to become a bigger player in the industry, capitalizing on the opportunity that Hurricane Sandy gave it by shipping additional water pump equipment to areas hit by the devastating storm.

But the anticipated positive results from the merger haven't yet fully materialized. In its most recent quarter, the Tyco merger clearly helped boost revenue substantially from year-ago levels, but future sales guidance nevertheless came in below expectations. A coming shortfall in earnings also disappointed more optimistic stock analysts.

Moreover, Pentair faces a changing competitive environment. Last year, SPX had sought to buy Gardner Denver , with the combination involving substantial exposure to pumping equipment from both companies. Yet because Gardner Denver has accepted a deal with KKR to go private, SPX finds itself the subject of activist investors who would like it to focus on industrial pumping equipment, potentially making it a more direct competitor -- or potential takeover target -- for Pentair.

For Pentair to improve, it needs to find ways to earn more profits from its flow-control business. With the energy sector as the logical place to find growth, Pentair likely needs to focus its efforts beyond simple water management in order to move toward perfection in the near future.

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 best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

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

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

Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of Pentair. 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 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


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