Has Yum! Brands 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 Yum! Brands (YUM -0.18%) 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 a 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 Yum! Brands.

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Yum! Brands last year, the company hasn't built on the extra point it earned from 2010 to 2011, as revenue growth was offset by a decrease in dividend yield. Still, the stock has soared over the past year, rising by about a third.

Yum! is the company behind the popular KFC, Taco Bell, and Pizza Hut restaurant chains. Although the restaurants are well-known in the U.S., the company's real growth prospects have increasingly come from emerging markets like China, where the market isn't nearly as saturated as Yum!'s domestic footprint.

But, many fast-food companies have faced tough times lately. The combination of rising commodity costs for food ingredients, a weaker consumer class in some parts of the world, and higher wage costs have hurt Yum!, as well as peers Chipotle Mexican Grill (CMG 6.33%) and Latin America's Arcos Dorados (ARCO -1.65%). Chipotle has attracted the short-selling attention of David Einhorn, who argued that Yum!'s Taco Bell could end up stealing Chipotle's market share. Even perennial stalwart McDonald's (MCD -0.42%), whose franchises Arcos Dorados runs, posted a same-store sales decline of 1.8% in October, the company's first decline in nine years.

That hasn't hurt Yum! though. In its most recent quarter, Yum!'s strong growth continued, with 6% same-store sales gains in both the U.S. and China. With a new higher-end menu, average ticket prices are rising and, despite some arguing that recent restaurant IPO Chuy's (CHUY -1.80%) is a threat, its target audience is more casual dining than fast-food.

For Yum! to improve, it needs to get earnings up where its valuations suggest. High debt levels are also something the company can work on in its quest to get closer to 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.

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