Is NASDAQ OMX 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 Nasdaq OMX (NASDAQ: NDAQ  ) 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 Nasdaq'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 Nasdaq's key statistics:

NDAQ Total Return Price Chart

NDAQ Total Return Price data by YCharts.

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

(7%)

Fail

Improving profit margin

26.2%

Pass

Free cash flow growth > Net income growth

(17.5%) vs. 17.3%

Fail

Improving EPS

47.3%

Pass

Stock growth (+ 15%) < EPS growth

73.4% vs. 47.3%

Fail

Source: YCharts. *Period begins at end of Q2 2010.

NDAQ Return on Equity Chart

NDAQ Return on Equity data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

6.7%

Pass

Declining debt to equity

8.4%

Fail

Dividend growth > 25%

Initiated in 2012

Pass

Free cash flow payout ratio < 50%

20%

Pass

Source: YCharts. *Period begins at end of Q2 2010.

How we got here, and where we're going
Nasdaq doesn't come through with a flawless performance, but it did earn five out of nine possible passing grades. One failing grade only occurred because the net income has grown while free cash flow has fallen during our tracked period; however, Nasdaq's nominal free cash flow is actually higher than its net income. Nasdaq would have earned another passing grade if its share price had not taken off well in advance of its fundamental improvements. Can Nasdaq fix its weaknesses for our next review? Let's take a look at what the company's been doing to improve.

Last week, Nasdaq suffered a major technical breakdown in its trading systems that halted all Nasdaq-based trading, leaving the stock exchange in oblivion for almost three hours. My Foolish colleague Alex Dumortier notes that Nasdaq has been rather problem-plagued lately; Goldman Sachs' (NYSE: GS  ) trading systems sent erroneous orders to various exchanges, costing Goldman roughly $100 million in losses. The SEC now plans to fine Nasdaq for its system malfunction, which might just be adding insult to injury at this point. It wouldn't be the first regulatory smackdown for Nasdaq this year -- the SEC also pushed the exchange operator to pay afflicted firms $62 million as a result of its disastrous handling of last year's Facebook (NASDAQ: FB  ) block-busted IPO. Fool contributor Tim Brugger notes that the SEC has extracted a $10 million fine from Nasdaq for this debacle on top of the mandated restitution.

In other recent news, BATS Global Markets and Direct Edge Holdings have agreed to merge, which will create the second-largest stock exchange by volume, surpassing the Nasdaq, which has been a perennial silver medalist. BATS has had its own problems, but this new competitor might draw off some of Nasdaq's precious volume as companies seek out more secure (relatively speaking) alternatives for trading and launching IPOs.

Putting the pieces together
Today, Nasdaq 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.

The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.


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