Is Silicon Motion's Stock Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Silicon Motion (SIMO 0.88%) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Silicon Motion's story, and we'll be grading the quality of that story in several ways:

• Growth: Are profits, margins, and free cash flow all increasing?
• Valuation: Is share price growing in line with earnings per share?
• Opportunities: Is return on equity increasing while debt to equity declines?
• Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Silicon Motion's key statistics:

SIMO Total Return Price data by YCharts.

Sources: YCharts and Morningstar. *Period begins at end of Q1 2010. Free cash flow calculated from year-end 2010 to year-end 2012.

SIMO Return on Equity data by YCharts.

Source: YCharts. *Period begins at end of Q1 2010.

How we got here and where we're going
Silicon Motion wows with a perfect score, since we can't yet accurately analyze the company's dividend payouts relative to its free cash flow. However, it's important to recognize the limitations of any backwards-looking analysis. This may look impressive, but Silicon Motion has fallen hard from its early 2013 peak following disappointing earnings in the spring. Will that affect the company further in the months and years ahead, or has Wall Street overacted to bad news?

The April earnings report was actually one in a string of Silicon Motion disappointments -- the company also whiffed last fall on weak guidance and earlier this year on declining metrics. Over the past year, Silicon Motion shares are down 12%, and since the start of 2012 the stock has lost almost half of its value. It was after the latest disappointment that Needham analysts effectively gave up on the prospect of future gains after having ridden shares up almost from the beginning, downgrading coverage that began after the IPO to "hold" from its earlier "buy" status.

Silicon Motion's current valuation levels all point to a stock turning into a value trap. The stock's low price is even more notable when you realize that the company's current cash hoard accounts for nearly half the value of every share, and Silicon Motion's cash has actually been increasing throughout the period that it's suffered the greatest price declines.

However, Silicon Motion's latest earnings call indicates that this weak period may be coming to an end. Revenue and margins are both expected to grow from the completed quarter to the one set to report soon, and for the full year the company expects revenue to flatten out at worst and increase 10% at the high end from 2012's result. That does appear to offer limited upside on a fundamental basis, but considering the company's single-digit P/E, notable share growth could easily kick in with even moderate valuation expansion and not run the risk of pushing Silicon Motion into "overvalued" territory.

Silicon Motion's close relationship to Samsung also presents a long-term risk to growth as well as a major opportunity, depending on how close the Korean giant wishes to get with its chip supplier. Investors in a certain iPhone maker's suppliers know all too well the difficulties of investing over the long term based on a relationship between their smaller stock and a high-tech leader in a rapidly changing field. Silicon Motion, for its part, offered both great optimism for its eMMC segment and muted vagueness concerning its LTE transceivers -- which are both sold primarily to Samsung -- in its latest earnings. On balance, you can expect at least a solid dividend this year, but perhaps not much else.

Putting the pieces together
Today, Silicon Motion has many 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.

Keep track of Silicon Motion by adding it to your free stock watchlist.