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, and then decide if Chuy's (NAS: CHUY) 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 Chuy's.
What We Want to See
Pass or Fail?
Five-year annual revenue growth > 15%
One-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%
Five-year dividend growth > 10%
3 out of 10
Source: S&P Capital IQ. Total score = number of passes. *Three-year average annual growth rate.
Chuy's may have the best Tex-Mex food on the planet in this writer's opinion, but with only three points, the stock raises some concerns. Nevertheless, investors have eaten up shares since its July IPO, with the stock up better than 75% from its offering price.
In the future, investing historians may look back at 2012 and call it the Summer of the Restaurant IPO. Along with steakhouse purveyor Del Frisco's Restaurant Group (NAS: DFRG) and the triple-play of Bloomin' Brands (NAS: BLMN) and its Outback, Carrabba's, and Bonefish chains, Chuy's decided to get in on the action and make its push to expand beyond its regional focus. Add in the reemergence of Burger King (NYS: BKW) to the public markets, and investors had almost as many restaurants to invest in as they had to go eat lunch at.
Chuy's offers a festive restaurant atmosphere with low price points, which draws customers. However, what draws investors is that at Chuy's, getting people in the door with food is just the first step. As with many restaurants, the big margins are in drinks, and Chuy's does a good job of catering to thirsty patrons.
But not everyone's a fan of the stock or the food. As Fool contributor John Maxfield observed last month, Chuy's has plenty of competitors trying to emulate its approach to the restaurant business. Perhaps more importantly, the IPO served as an effective exit strategy for its former private-equity owners, who now own just 6% of the company. That doesn't scream confidence.
Even more concerning is Chuy's lack of growth. While burrito competitor Chipotle (NYS: CMG) posts high-single-digit same-store sales figures, Chuy's comps come in much lower.
For Chuy's to improve, it needs to get its debt under control and focus on boosting its margins to whatever extent is possible. With the company likely to stay in hyper-growth mode for some time, don't expect Chuy's to reach perfection, but it could get closer in the years to come if things work out well.
No stock is a sure thing, but some stocks are a lot closer to perfection 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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The article Is Chuy's the Perfect Stock? originally appeared on Fool.com.
Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Chipotle. Motley Fool newsletter services have recommended buying shares of 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 a disclosure policy.