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 Darden Restaurants (NYSE: DRI ) 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 Darden Restaurants.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||7.6%||Fail|
|1-Year Revenue Growth > 12%||6.3%||Fail|
|Margins||Gross Margin > 35%||23.5%||Fail|
|Net Margin > 15%||6.2%||Fail|
|Balance Sheet||Debt to Equity < 50%||94.2%||Fail|
|Current Ratio > 1.3||0.50||Fail|
|Opportunities||Return on Equity > 15%||25%||Pass|
|Valuation||Normalized P/E < 20||14.55||Pass|
|Dividends||Current Yield > 2%||4.1%||Pass|
|5-Year Dividend Growth > 10%||28.3%||Pass|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With four points, Darden Restaurants needs to keep cooking a little longer. The restaurant chain has struggled against the same trends as its competitors lately, and it's unclear whether those trends will reverse themselves in the near future.
Darden isn't a well-known name, but its restaurant chains are. Darden is the company behind Olive Garden, Red Lobster, LongHorn Steakhouse, and a number of other restaurant names.
Darden has set itself apart with some unusual moves in the area of sustainability and workplace benefits. Like Starbucks (Nasdaq: SBUX ) , Darden is one of the few companies to offer health insurance benefits to part-time workers. Darden is also taking steps to promote rebuilding of fisheries, solar energy at its corporate restaurant support center, and reduction of energy and water use and waste production.
But lest you think that makes the company a bad investment, think again. Even though it comes with a much lower valuation than high-flying Chipotle (NYSE: CMG ) and Panera (Nasdaq: PNRA ) , Darden carries a dividend yield above 4% -- while many of its competitors pay no dividend at all.
Still, Darden faces challenges. In its most recent quarter, Darden reported that earnings fell 6% despite sales jumping 9%. Then, earlier this week, the company announced that 2012 growth would come far weaker than previously expected. One problem that Darden has is that rising food prices have crimped margins, making it harder to maintain profit growth. Brinker International (NYSE: EAT ) and DineEquity (NYSE: DIN ) are in the same boat, but the industry remains very competitive.
For Darden to keep improving, it needs to focus on getting margins back up and eventually decreasing debt. If it can build up a stronger balance sheet, then an eventual economic recovery could bring Darden a lot closer to perfection in the next few years.
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 the best investments from the rest.
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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."