Is Marvell 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 Marvell Technology Group's (MRVL -4.77%) recent results tell us about its potential for future gains.

What the numbers tell you
The graphs you're about to see tell Marvell'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 Marvell'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 Marvell's share price has kept pace with its earnings growth, that's another good sign that its stock can move higher.

Is Marvell 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 Marvell'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 Marvell's key statistics:

MRVL Total Return Price data by YCharts.

Source: YCharts. *Period begins at end of Q3 2009 (Oct. 27 per Marvell 10-Q).

MRVL Return on Equity data by YCharts.

Source: YCharts. *Period begins at end of Q3 2009 (Oct. 27 per Marvell 10-Q).

How we got here and where we're going
Marvell's recently instituted dividend, combined with bottom-line numbers that remain stronger than 2009's levels in spite of a large decline of late, add up to a solid six of nine possible passing grades. However, declining free cash flow and profit margins are points of concern. Can Marvell turn these sliding metrics around in 2013?

If that's to be the case, Marvell will need to produce a major turnaround to its 2012 ending. Thus far, disappointing guidance has tamped down any investor enthusiasm, contributing to more than one stock-price plunge in the second half of the year. Although Marvell remains profitable and has produced enough free cash flow to eliminate its debt and institute a sustainable dividend, its declining financials have pushed its valuation to one of the lowest in the chip making industry. Texas Instruments (TXN -2.44%), despite suffering similar sales declines, maintains a P/E that's over five points higher. It certainly hasn't helped that Research In Motion (BB -1.43%), a major customer, is fast becoming an also-ran in the smartphone industry.

Marvell's been a key supplier to the hard disk drive industry, which has had ample time to recover. Seagate (STX) and Western Digital (WDC -3.32%) have both produced big gains for shareholders this year, but impressive growth by the industry's de facto duopoly has yet to trickle down to Marvell. That might be because LSI (NYSE: LSI) has been making gains all year, and as a major hard-disk controller competitor to Marvell, it's likely to be gaining market share in the process.

Marvell has two easily identified areas of opportunity: the new Microsoft (MSFT -1.27%) Surface tablet, and in Chinese smartphones. The Surface, which uses Marvell's wireless controllers, appears to be selling "well," but until hard data is available, it's going to be difficult to project the new tablet's impact on Marvell's bottom line. The Chinese market also has its difficulties -- demand for TD-SCDMA chips has been below expectations, and fierce competition from Spreadtrum Communications (NASDAQ: SPRD) and Qualcomm (QCOM -2.36%) will make it difficult to maintain strong margins while simultaneously expanding market share.

Marvell's hardly down and out, but it's got to be laser-focused on its big opportunities to avoid losing the race to more determined foes. Its upcoming year remains uncertain, and there's presently little indication that its falling metrics will bounce back in 2013.

Putting the pieces together
Today, Marvell 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.