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 McDonald's (NYSE: MCD ) 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 McDonald's.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||5.2%||Fail|
|1-Year Revenue Growth > 12%||11.7%||Fail|
|Margins||Gross Margin > 35%||39.6%||Pass|
|Net Margin > 15%||20.3%||Pass|
|Balance Sheet||Debt to Equity < 50%||87.2%||Fail|
|Current Ratio > 1.3||1.17||Fail|
|Opportunities||Return on Equity > 15%||38.2%||Pass|
|Valuation||Normalized P/E < 20||18.37||Pass|
|Dividends||Current Yield > 2%||3.1%||Pass|
|5-Year Dividend Growth > 10%||21.2%||Pass|
|Total Score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at McDonald's last year, the company has kept its six-point score. But shareholders have to be happy about the stock's roughly 10% rise over the past year, albeit having given up bigger gains from earlier in the year.
McDonald's remains atop the fast-food industry and has thrived largely on the success of its franchise model. By keeping company-owned stores to a minimum, McDonald's can focus on providing high-margin products and services to franchisees without the business risk that specific locations bring. That's a model that both Burger King and Yum! Brands (NYSE: YUM ) have sought to emulate in order to capture the same efficiencies that the Golden Arches has in place.
Moreover, innovation at McDonald's has forced other players in the industry to adapt. For instance, as the summer months begin, its smoothie sales will likely be an increasingly important part of its McCafe experience. With McDonald's threatening Jamba (Nasdaq: JMBA ) on its own turf, Jamba has had to widen its product menu as well. Similarly, Starbucks (Nasdaq: SBUX ) bought Evolution Fresh late last year to try to distinguish itself from McCafe's successful offerings.
But McDonald's future growth is starting to come into question. Same-store sales figures have been looking weaker, making faster-growing competitor Chipotle (NYSE: CMG ) look more attractive by comparison. With the company already having pushed hard in emerging markets, McDonald's will have to push even harder to create new opportunities around the world.
To improve, McDonald's needs to make sure its balance sheet doesn't start deteriorating and focus on growth initiatives. Unless it can find them, McDonald's will have a tough time keeping its valuation up and staying on course to move toward perfection.
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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