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 (NYSE: YUM ) 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 Yum! Brands.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||5%||Fail|
|1-Year Revenue Growth > 12%||8.4%||Fail|
|Margins||Gross Margin > 35%||26.9%||Fail|
|Net Margin > 15%||10.2%||Fail|
|Balance Sheet||Debt to Equity < 50%||154.9%||Fail|
|Current Ratio > 1.3||1.04||Fail|
|Opportunities||Return on Equity > 15%||67.4%||Pass|
|Valuation||Normalized P/E < 20||23.12||Fail|
|Dividends||Current Yield > 2%||2.1%||Pass|
|5-Year Dividend Growth > 10%||31.3%||Pass|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Yum! Brands last year, the restaurateur has picked up a point, as its dividend nosed above the 2% level. Yet even though the score looks weak, Yum! has made big progress in boosting growth while improving its balance sheet.
Yum! is perhaps best known for its early penetration into the growing Chinese market. China has become increasingly important to Yum!, as in the third quarter, the region was responsible for nearly 60% of its operating profits. Although food price inflation and higher labor costs are threatening growth, Yum! may retain a huge competitive advantage against rivals that put less emphasis on affordable menu items.
But Yum! has had to work harder to keep up domestically. For instance, this past summer, Yum!'s Taco Bell unit offered premium frozen beverages to match up against McDonald's (NYSE: MCD ) , Dunkin' Brands (Nasdaq: DNKN ) , and Starbucks (Nasdaq: SBUX ) . And as Starbucks starts to move more strongly into China, Yum! could soon have to deal with the loss of its commanding presence in the emerging nation.
For investors, though, the biggest concern may be Yum!'s hefty price multiple. Although its earnings multiple is cheaper than that of some other restaurant companies, including Panera Bread (Nasdaq: PNRA ) and Chipotle (NYSE: CMG ) , Yum! will need China to keep delivering the goods at a fast pace to justify its valuation. If it falls short, then Yum! may not look like a perfect stock for years to come.
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."