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 Sonic (Nasdaq: SONC ) 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 Sonic.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||(6.1%)||Fail|
|1-Year Revenue Growth > 12%||(1.1%)||Fail|
|Margins||Gross Margin > 35%||52.0%||Pass|
|Net Margin > 15%||6.2%||Fail|
|Balance Sheet||Debt to Equity < 50%||1061.2%||Fail|
|Current Ratio > 1.3||1.37||Pass|
|Opportunities||Return on Equity > 15%||80.2%||Pass|
|Valuation||Normalized P/E < 20||16.07||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Sonic last year, the company has kept its four-point score. But shareholders in the restaurant chain have to be disappointed in its stock's performance, as its roughly flat showing lags the overall market badly.
In the fast-food world, Sonic takes a back seat to giants McDonald's (NYSE: MCD ) and newly public Burger King (NYSE: BKW ) . Between its corporate-owned and franchised locations, Sonic has 3,500 restaurants in its network across the United States. Despite that scope, however, Sonic's financials don't make a huge splash, as revenue is just a quarter of what Burger King makes and barely 2% of what McDonald's pulls in.
Still, Sonic has tried to reverse course and start growing again. With attempts to turn the company around including new items on its menu and boosting its marketing campaigns, investors have gotten more excited about the stock. The moves have had an impact, too, as Sonic has been doing fairly well lately. For its fiscal third quarter that ended May 31, the company posted better-than-expected earnings despite seeing revenue decline.
The big challenge for Sonic, though, comes from increased competition. Pricier casual-dining restaurants like the newly public Bloomin' Brands (Nasdaq: BLMN ) and Chuy's (Nasdaq: CHUY ) are trying to attract lower-price-point customers, which could end up poaching business from Sonic. Meanwhile, Sonic isn't immune to the food-price inflation that has hit the entire industry.
For Sonic to improve, it needs to find a way to get sales moving back in the right direction. Until that happens, Sonic won't move much 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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