Has Sonic Become the Perfect Stock?

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.

Factor

What We Want to See

Actual

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.

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.

Sonic may not be perfect, but we've got some other ideas you might like better. Let me invite you to learn about three smart long-term stock plays in the Fool's latest special report. It's yours for the taking and is absolutely free, but don't miss out -- click here and read it today.

Click here to add Sonic 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. The Motley Fool owns shares of McDonald's. Motley Fool newsletter services have recommended buying shares of McDonald's. 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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