Is Walgreen Destined for Greatness?

Every investor can appreciate a stock that consistently beats the Street without getting ahead of its fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with improving financial metrics that support strong price growth. Let's take a look at what Walgreen's (WBA -1.33%) recent results tell us about its potential for future gains.

What the numbers tell you
The graphs you're about to see tell Walgreen's story, and we'll be grading the quality of that story in several ways.

Growth is important on both top and bottom lines, and an improving profit margin is a great sign that a company's become more efficient over time. Since profits may not always reported at a steady rate, we'll also look at how much Walgreen's free cash flow has grown in comparison to its net income.

A company that generates more earnings per share over time, regardless of the number of shares outstanding, is heading in the right direction. If Walgreen's share price has kept pace with its earnings growth, that's another good sign that its stock can move higher.

Is Walgreen managing its resources well? A company's return on equity should be improving, and its debt to equity ratio declining, if it's to earn our approval.

Healthy dividends are always welcome, so we'll also make sure that Walgreen's dividend payouts are increasing, but at a level that can be sustained by its free cash flow.

By the numbers
Now, let's take a look at Walgreen's key statistics:

WAG Total Return Price data by YCharts.

Source: YCharts. * Period begins at end of Walgreen FY (August) 2009.

WAG Return on Equity data by YCharts.

Source: YCharts. * Period begins at end of Walgreen FY (August) 2009.

How we got here and where we're going
Walgreen earns a reasonable, but not impressive, five out of nine possible passing grades. The company's recent earnings slide has hurt its score, as has a suddenly skyrocketing debt-to-equity level. On the other hand, Walgreen can easily sustain its growing dividend payouts at its current level of free cash flow, which should reassure yield-hungry investors.

Walgreen's been on a bit of a slide since hitting a 52-week high in October. Part of that can be blamed on the love-hate triangle the company's in with both Express Scripts (ESRX) and CVS Caremark (CVS -1.07%). When the latter two reported earnings earlier this month, it was like a one-two punch to the gut for Walgreen.

Express Scripts has patched up its rough relationship with Walgreen and will be once again managing prescriptions for the pharmacy chain, but has been working with CVS the whole time. While those two were giving each other the cold shoulder, CVS was putting on the hard sell for Walgreen pharmacy customers, and it worked -- CVS is now trying to lure 60% of former Walgreen pharmacy customers to its side, up from the 55% it already claims to have signed up for its auto-refill program. On the plus side, Walgreen's doing better than pharmacy-sector third wheel Rite Aid (RAD 24.00%), the only stock of the three to post a 52-week stock price decline.

Although Walgreen may have headwinds as it attempts to regain ground lost during this tiff, my fellow Fool Tim Brugger points out that Walgreen's long-term picture remains fairly bright. The company's major buy-in on European pharmacy leader Alliance Boots hit the bottom line, and Express Scripts will now be contributing to that bottom line again going forward. That should help turn some of those failing grades into passing marks.

Putting the pieces together
Today, Walgreen has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.