Is Yum! Brands the Perfect Stock?

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 Yum! Brands (NYSE: YUM  ) 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 different 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 Yum! Brands.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 3.8% fail
  1-Year Revenue Growth > 12% 2.6% fail
Margins Gross Margin > 35% 27.1% fail
  Net Margin > 15% 9.9% fail
Balance Sheet Debt to Equity < 50% 233.2% fail
  Current Ratio > 1.3 0.95 fail
Opportunities Return on Equity > 15% 89.5% pass
Valuation Normalized P/E < 20 23.25 fail
Dividends Current Yield > 2% 1.97% fail
  5-Year Dividend Growth > 10% 32.6% pass
       
  Total Score   2 out of 10

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

With a score of just 2, shares of this fast-food maven -- which operates Pizza Hut, KFC, and Taco Bell restaurants -- may not look too yummy. But despite its financial metrics, Yum! has been making some smart moves lately.

With fast food having become a mature industry, it's tough for any company to score well on some of these measures. Even top dog McDonald's (NYSE: MCD  ) has only managed single-digit revenue growth in recent years. And while the Golden Arches has done an amazing job keeping its margins up, many other competitors, including Wendy's/Arby's (NYSE: WEN  ) and Domino's Pizza (NYSE: DPZ  ) , have net margins well below Yum!'s. Moreover, most players in the industry have fairly high debt levels.

Where Yum! shines, however, is in its emerging-market strategy. The company has made huge inroads in China, where its sales now eclipse its U.S. revenue. With three times as many stores in China as McDonald's, Yum clearly is stealing a march in the important emerging nation.

Yum!'s rapidly rising dividend makes up for a somewhat rich valuation. As long as it can hold off competition from rising niche players like Chipotle Mexican Grill (NYSE: CMG  ) , Yum! should see itself get a lot closer to perfection in the 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.

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

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Chipotle is a Motley Fool Rule Breakers choice and a Motley Fool Hidden Gems selection. The Fool owns shares of Chipotle, Domino's Pizza, and Yum! Brands. 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 Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 16, 2010, at 4:17 PM, hportofino19 wrote:

    Growth %'s are low do to the amount of stores in the U.S that aren't performing. Remember, most of the stores are here. The company has a goal of opening over 15,000 stores in China (at least) and with only 3,000 life to date, I believe that the growth %'s will increase over the years. Also, India will have a similar impact on their future growth. I love YUM! and I love the fact that they are building a name and loyalty before others arrive, that to me is growing a long term business. Long on YUM!

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