Is Tractor Supply Company 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 Tractor Supply Company (TSCO 2.20%) fit the bill? Let's 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 Tractor Supply'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 look at Tractor Supply's key statistics:

TSCO Total Return Price data by YCharts.

Source: YCharts.
*Period begins at end of Q4 2010.

TSCO Return on Equity (TTM) data by YCharts.

Source: YCharts.
*Period begins at end of Q4 2010.

How we got here and where we're going
We last looked at Tractor Supply just over a year ago, and it's lost one of the passing grades it picked up then to finish with a respectable (if not stupendous) six out of nine possible passing grades today. One major deficiency here is the company's falling free cash flow, which has diverged from net income growth over the past three years. Because of this drop, Tractor Supply now pays out over half of its free cash flow as regular dividend payments, which earned it one failing grade on this test. The company's stock growth has also surpassed the gains in its earnings per share by a fairly wide margin, which could be worrisome for value investors if the bottom line begins to sputter. Is Tractor Supply's stock growth going to be sustainable, or will the farm and ranch retailer find itself hogtied by fundamental stumbles? Let's dig a little deeper to find out.

Tractor Supply recently topped Wall Street's expectations on both its top and bottom lines for the fiscal fourth quarter, thanks to a highly diversified and largely evergreen product portfolio, which produced a solid 3.5% uptick in same-store sales. However, the company disappointed shareholders with its forward guidance. To counteract this, Tractor Supply announced a multiyear, multibillion-dollar investment plan, which focuses primarily on the expansion of store footprints throughout the United States. Tractor Supply's management plans to launch between 102 and 106 stores this year, and will increase store counts at a rate of about 10% per year for the next several years.

While the company doesn't appear to see a significant rise in sales and administrative expenses accompanying the opening of hundreds of new stores, investors seem to fear a reduction in same-store sales growth as the company stretches itself (perhaps too thinly) across the heartland. Tractor Supply also announced a $2 billion share repurchase program as management seems optimistic about hitting its long-term growth targets.

Fool contributor Mark Lin notes that Tractor Supply's private-label products, which serve a niche customer segment of ranchers, tradesmen, and recreational farmers, have fared very well over the past few years. Consequently, the company now plans to expand its pet food line and its C.E. Schmidt brand of blue-collar workwear. Despite these positive notes, Oppenheimer analysts recently downgraded Tractor Supply from buy to hold, citing a limited upside potential for earnings and a heightened valuation multiple. Tractor Supply's forward P/E ratio of 25.6  is at one of its highest levels in five years, but this 75-year-old brick-and-mortar retailer nonetheless offers a compelling history of market-topping gains. Investors need to decide whether or not near-record valuations can be offset by stronger earnings growth in the near future -- if not, it might be time to move to the sidelines.

Putting the pieces together
Today, Tractor Supply 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.