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 (NAS: 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.
What We Want to See
Pass or Fail?
5-Year Annual Revenue Growth > 15%
1-Year Revenue Growth > 12%
Gross Margin > 35%
Net Margin > 15%
Debt to Equity < 50%
Current Ratio > 1.3
Return on Equity > 15%
Normalized P/E < 20
Current Yield > 2%
5-Year Dividend Growth > 10%
4 out of 10
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With just four points, Sonic doesn't serve up a delicious score. The restaurant chain is trying to survive a tough environment for fast food while dealing with crushing debt.
The biggest threat to the entire fast-food industry these days is the rising cost of commodities. Chipotle (NYS: CMG) , for instance, has seen margins drop substantially as a result of higher food costs. McDonald's (NYS: MCD) passed some of those food costs on to customers in the form of higher menu prices, but it didn't stop same-store sales from rising 5.6% in the second quarter. Even Yum! Brands (NYS: YUM) rode the wave of its Chinese growth to strong results, although its U.S. operations saw big drops in comps and profit.
Even though Sonic and competitor Wendy's (NYS: WEN) haven't seen as strong financial performance, their shares have both gone up substantially. Although Sonic beat earnings expectations in its most recent quarter, one-time items related to repaying and refinancing its debt loomed large.
But that isn't stopping the company from trying to innovate. The company has joined Starbucks (NAS: SBUX) in testing beer and wine offerings on their menus. Given Sonic's drive-in focus, that may not be a huge growth mover, but it at least shows that the company is trying out new ideas.
For Sonic, the key to its future is resolving its debt. If it can get that debt paid down, it could eventually come a lot closer to perfection.
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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At the time thisarticle was published Fool contributorDan Caplingerdoesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Yum! Brands, Starbucks, and Chipotle.Motley Fool newsletter serviceshave recommended buying shares of Yum! Brands, Starbucks, Chipotle, and McDonald's, as well as creating an iron condor position in Chipotle. 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 adisclosure policy.
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