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 Famous Dave's (Nasdaq: DAVE ) 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 Famous Dave's.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||5.8%||Fail|
|1-Year Revenue Growth > 12%||4.4%||Fail|
|Margins||Gross Margin > 35%||20.9%||Fail|
|Net Margin > 15%||3.6%||Fail|
|Balance Sheet||Debt to Equity < 50%||32.3%||Pass|
|Current Ratio > 1.3||0.83||Fail|
|Opportunities||Return on Equity > 15%||16.6%||Pass|
|Valuation||Normalized P/E < 20||16.38||Pass|
|Dividends||Current Yield > 2%||0%||Fail|
|5-Year Dividend Growth > 10%||0%||Fail|
|Total Score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With only three points, Famous Dave's doesn't serve up perfection. The restaurant chain is too small to show up on most investors' radars, and so far, it can't match the stronger growth of some of its competitors.
Famous Dave's is a barbecue restaurant company, with a mix of company-owned and franchised restaurants. During the recession, the company had a hard time keeping sales up, as same-store sales fell. But a change in management helped Famous Dave's rebound, with store closings and lower franchise fees helping to reinvigorate the company.
If you believe in the turnaround story, then Famous Dave's is quite a value. By comparison, Chipotle (NYSE: CMG ) has growth rates that are roughly four times as fast, but you'll pay four times the multiple for the stock. Similarly, Panera Bread (Nasdaq: PNRA ) has also grown at a faster pace yet carries a more expensive price tag. Eventually, Chipotle and Panera will lose steam, yet Famous Dave's has potential to accelerate its growth in a recovering economy -- which could boost its multiple as well as its earnings.
Still, Famous Dave's faces the same challenges as many restaurants. McDonald's (NYSE: MCD ) is changing its menu to try to offset the impact of food price inflation. Yum! Brands (NYSE: YUM ) is also dealing with higher food prices, which hit it especially hard because of its low price points. By contrast, diners at Famous Dave's already expect somewhat higher prices, so the restaurant arguably has more room to raise prices to try to improve its slim margins.
For Famous Dave's to achieve perfection, it needs to start a more ambitious expansion project to boost revenue. Once it has a solid growth trajectory, Famous Dave's can then focus on getting the rest of its financial house in order.
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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