Is Consolidated Edison 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 look at what Consolidated Edison's (ED -1.25%) recent results tell us about its potential for future gains.

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

Is ConEd 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 ConEd'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 ConEd's key statistics:

ED Total Return Price data by YCharts.

Source: YCharts.
*Period begins at end of Q3 2009.

ED Return on Equity data by YCharts.

Source: YCharts.
*Period begins at end of Q3 2009.

How we got here and where we're going
Five out of nine possible passing grades is a decent score, but not a particularly impressive one. ConEd's free-cash-flow rebound from negative levels three years ago helped it in one test, but the utility hasn't managed to keep its dividend payouts at a sustainable level recently, despite little in the way of any increase. Can ConEd push its free cash flow high enough to earn more points on our dividend tests?

There may be one major impediment to ConEd's continued stability, and if you live on the East Coast you probably experienced it firsthand. I'm speaking, of course, of Hurricane Sandy, which knocked out power all up and down the coast, including to customers of First Energy's (FE -1.14%) Jersey Central Power & Light and Northeast Utilities' (ES -1.75%) Connecticut Light & Power, as well as to hundreds of thousands of ConEd-served New Yorkers.

The damage extended at least as far south as Northern Virginia, home of Fool HQ and where I was living at the time of the hurricane. Served by Dominion Resources (D -1.02%), Northern Virginia has had its fair share of major outages over the past couple of years, but the damage in New York was virtually unprecedented, and investor reactions to Sandy's wrath have wiped out a year of gains  for all of the aforementioned utilities except Northeast. The problem, particularly for ConEd and Dominion, is that they don't have reserve funds on hand for storm recovery. With damage estimates for the New York area spiraling into the billions, you can be certain that ConEd will be spending a big chunk of change on repair work, especially since it provided one of the destructive highlights of Sandy's wrath when one of its transformers blew up in spectacular fashion.

Before Sandy blew through the East Coast, ConEd's biggest issue -- at least here in Fooldom -- is its place in what Morgan Housel calls the "dividend bubble." A number of utilities have been on a multiyear tear coming out of the recession, and ConEd was actually one of the strongest overall performers in the sector last year. Reality has set in this year, leaving ConEd and most of its peers flat as fundamentals struggle to catch up with stock prices. One of the few exceptions is NextEra Energy (NEE -1.36%), which started rising later than most and thus had more room to gain this year. ConEd's P/E remains above its five-year average of 13.4, but the trend has moved lower recently, indicating the beginnings of what may be a longer pullback.

Putting the pieces together
Today, ConEd 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.