Is Xerox 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 Xerox (NYSE: XRX  ) 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 Xerox'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 Xerox's key statistics:

XRX Total Return Price Chart

XRX Total Return Price data by YCharts.

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

12.9%

Fail

Improving profit margin

71.1%

Pass

Free cash flow growth > Net income growth

37.5% vs. 93.2%

Fail

Improving EPS

87.9%

Pass

Stock growth (+ 15%) < EPS growth

24.2% vs. 87.9%

Pass

Source: YCharts. * Period begins at end of Q3 2010.

XRX Return on Equity (TTM) Chart

XRX Return on Equity (TTM) data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

62.7%

Pass

Declining debt to equity

(5.2%)

Pass

Dividend growth > 25%

35.3%

Pass

Free cash flow payout ratio < 50%

10.8%

Pass

Source: YCharts. * Period begins at end of Q3 2010.

How we got here and where we're going
Xerox comes through with flying colors by scoring seven out of nine possible passing grades in its second assessment, which is the same score it earned last year. One of those failing grades was only awarded because net income growth has surpassed the gains in free cash flow during the three-year tracking period -- however, Xerox's nominal free cash flow is actually higher than its net income, and has been trending higher in recent quarters even as the bottom line stagnates. Unfortunately, Xerox's revenue growth has also stagnated due to the long-term decline in its document technology segment. How might Xerox push its revenue growth over the next few years and improve on its few minor weaknesses and become a truly great stock? Let's dig a little deeper to find out.

Xerox recently delivered lackluster third-quarter results, an outcome dragged down by dwindling demand for printers and copiers around the world. However, Xerox's shares spent much of 2013 in an upswing on news that the company is aiming for another round of restructuring to get rid of non-core assets and find new revenue growth from long-term IT-service-based contracts. Fool contributor Tim Brugger notes that Xerox recently sold a portion of its solid ink engineering and development business to 3-D printer leader 3D Systems (NYSE: DDD  ) in a deal worth $32.5 million in cash. A long-term partnership between Xerox and 3D Systems might allow Xerox to leverage new 3-D printing capabilities to find new revenue streams from its business hardware clients.

In addition to this, Xerox's Palo Alto Research Center (PARC) subsidiary is also developing a unique technology to print electronic circuitry, which isn't part of the sale to 3D Systems. Xerox also recently announced the acquisition of German customer care service provider Invoco, which beefs up its business process outsourcing capabilities in overseas and emerging markets. Fool contributor Sean Williams points out that the move is a clear example of Xerox's turnaround plan in action -- this strategy aims to produce more than two-thirds of Xerox's total revenue from IT services within five years -- includes diversification efforts away from its highly commoditized printing business.

Xerox should also benefit from Obamacare health reforms as the company is highly involved in processing Medicaid claims, payment processing, and state-run exchange development. It is solely responsible for processing Medicaid claims in the state of California, and has also been responsible for designing Nevada's state-run health exchange. California plans to sign up about 1.4 million newly insured people for Medicaid, which will certainly boost demand for Xerox's document processing services. Xerox's subsidiary Buck Consultants has built an employer-based privatized exchange called RightOpt to help retirees manage their corporate health benefits plan. Quite recently, Xerox also inked a $100 million deal with the Texas Department of Transportation to deliver toll processing and invoicing services.

Putting the pieces together
Today, Xerox 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.

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