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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 Arcos Dorados (NYSE: ARCO ) 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 Arcos Dorados.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||11.1%*||Fail|
|1-Year Revenue Growth > 12%||11.8%||Fail|
|Margins||Gross Margin > 35%||15.8%||Fail|
|Net Margin > 15%||2.7%||Fail|
|Balance Sheet||Debt to Equity < 50%||100%||Fail|
|Current Ratio > 1.3||1.17||Fail|
|Opportunities||Return on Equity > 15%||15.1%||Pass|
|Valuation||Normalized P/E < 20||28.48||Fail|
|Dividends||Current Yield > 2%||1.8%||Fail|
|5-Year Dividend Growth > 10%||NM||NM|
|Total Score||1 out of 9|
Source: S&P Capital IQ. NM = not meaningful; Arcos Dorados started paying a dividend in June 2011. Total score = number of passes. *3 1/2-year growth rate.
With just one point, Arcos Dorados doesn't do very well on our scale. The newly public restaurant chain has gotten a lot of positive publicity, but its share price hasn't kept up, losing half its value over the past year.
Arcos Dorados combines a couple of potentially lucrative trends. It operates McDonald's (NYSE: MCD ) franchises in Latin America, giving investors exposure both to the growth power that the McDonald's brand has generated around the world as well as to Latin America's particularly explosive rise of middle-class consumers. That has led to double-digit same-store sales rises, dwarfing even high-growth standouts Chipotle Mexican Grill (NYSE: CMG ) and Panera Bread (Nasdaq: PNRA ) , let alone the much lower industry average.
But even Arcos has its challenges. Weakness in the Brazilian currency has weakened growth in U.S. dollar terms there. More important, a rocky economy may lead to slowing expansion plans; Arcos planned to open 130 restaurants this year but only had 18 openings in the first half of 2012.
In its most recent quarter, Arcos fell a bit short of earnings estimates, but that wasn't particularly unusual given high raw-ingredient prices. Both Chipotle and Buffalo Wild Wings (Nasdaq: BWLD ) similarly missed expectations.
For Arcos to get moving in the right direction, it needs to keep growing and find ways to boost its operational performance. Once Latin American growth returns to normal, Arcos will be in a good position to thrive.
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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