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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 Starbucks (Nasdaq: SBUX ) 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 Starbucks.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Growth||5-year annual revenue growth > 15%||10.9%||Fail|
|1-year revenue growth > 12%||9.5%||Fail|
|Margins||Gross margin > 35%||58.4%||Pass|
|Net margin > 15%||8.8%||Fail|
|Balance sheet||Debt to equity < 50%||15%||Pass|
|Current ratio > 1.3||1.55||Pass|
|Opportunities||Return on equity > 15%||28.1%||Pass|
|Valuation||Normalized P/E < 20||27.36||Fail|
|Dividends||Current yield > 2%||1.6%||Fail|
|5-year dividend growth > 10%||NM||NM|
|Total Score||4 out of 9|
Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful; Starbucks started paying a dividend in 2010. Total score = number of passes.
With four points, Starbucks puts in a decent performance, but it's not the caffeine jolt you might expect from the company. After years of domination over the premium coffee industry that it pioneered, Starbucks has had to deal with strong competition on many fronts.
On one hand, barriers to entry for building a coffeehouse aren't all that substantial. Competing locations from Peet's (Nasdaq: PEET ) and Caribou Coffee (Nasdaq: CBOU ) saturate potential markets for coffee drinkers, although neither has managed to post margins or returns on equity that even approach Starbucks'.
More serious competition has come from beyond the coffeehouse realm. McDonald's (NYSE: MCD ) in particular has challenged Starbucks with its value-priced McCafe coffee offerings. Green Mountain Coffee Roasters (Nasdaq: GMCR ) and its Keurig coffee machines have pushed many coffee drinkers away from retail coffee stores entirely.
On the positive side, the company sees major growth prospects internationally, especially in China. The question is whether it can maintain its strong position now that it clearly has a target on its back. With Starbucks having started paying a dividend last year, some fear that its days as a growth leader are behind it -- and that it won't gain status as a perfect stock going forward.
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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