Is E TRADE Financial Corporation 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 E*TRADE Financial (ETFC) 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 E*TRADE'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 E*TRADE's key statistics:

Source: YCharts. * Period begins at end of Q1 2011.

Source: YCharts. * Period begins at end of Q1 2011.

How we got here and where we're going
E*Trade has picked up another passing grade since its last assessment to finish with a strong five-of-seven score. While the online broker continues to grapple with declining revenue, investors have finally caught on to the improvement on E*Trade's bottom line, and have sent shares soaring nearly 150% since the start of 2013. E*Trade's free cash flow also looks solid on a nominal basis despite continuing to decline from earlier levels, as its trailing 12-month result on this metric is over three times what it recorded in net income. Can E*Trade reverse the decline on its top line and in its free cash flow to pick up a rare perfect score when we examine it next year? Let's dig deeper to find out.

E*Trade flew through 2013 as it returned to profitability on the back of improving loan quality and growth in its core brokerage business. However, 2014 has not been quite as kind, despite the fact that E*Trade continued its momentum in the first quarter. A great deal of pain has been blamed on the new Michael Lewis high-frequency trading expose Flash Boys, which frightened investors by highlighting a less-known element of the company's business. That fear has subsided somewhat since, but it's arguable that the sell-off was senseless to start with, as E*Trade actually divested its market-making business last year, greatly reducing its direct exposure to high-frequency trading.

Since emerging from the financial crisis, E*Trade has struggled to overcome the weight of billions of dollars in bad mortgages, which could actually become more dangerous next year, according to Fool financial specialist John Maxfield. Roughly 80% of E*Trade's home equity loans -- most of which were originated with minimal documentation at the height of the housing bubble -- won't begin amortizing until 2015. While E*Trade's growth looks attractive now, a second wave of defaults next year would certainly turn all that progress around in a hurry.

E*Trade's core brokerage business has also come under increasingly intense competition. Bank of America's Merrill Lynch segment is undercutting many brokerages with a rock-bottom commission fee that's 30% lower than E*Trade's standard $9.99 commission. But E*Trade has made savvy moves in both of these areas, divesting $800 million in loans during the first quarter and growing daily trading volumes and margin balances to the highest levels since the financial crisis. If it can continue to reduce the weight of bad loans while simultaneously fending off aggressive brokerage competitors, there's no reason not to expect further growth in E*Trade's shares over the coming year.

Putting the pieces together
Today, E*TRADE 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.