Is hhgregg, Inc. 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 hhgregg (NYSE: HGG  ) 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 hhgregg'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 hhgregg's key statistics:

HGG Total Return Price Chart

HGG Total Return Price data by YCharts.

Passing Criteria

3-Year* Change 

Grade

Revenue growth > 30%

12.6%

Fail

Improving profit margin

(99.6%)

Fail

Free cash flow growth > Net income growth

6,524.5% vs. (99.5%)

Pass

Improving EPS

(100%)

Fail

Stock growth (+ 15%) < EPS growth

(33.3%) vs. (100%)

Fail

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

HGG Return on Equity (TTM) Chart

HGG Return on Equity (TTM) data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

(99.6%)

Fail

Declining debt to equity

No debt

Pass

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

How we got here and where we're going
hhgregg has suffered a horrendous decline from its initial assessment last year, dropping from five passing grades in 2013 to just two out of seven passes today. The dangerous decline in hhgregg's net margins that we saw last year has proven to be its undoing, as the company has now lost its positive EPS momentum at the same time that its top line has begun to stagnate. The single saving grace here, free cash flow growth, was only boosted by the fact that it started from such a narrowly negative level that any return to positive territory would have resulted in a huge growth rate, which is the same technicality that earned hhgregg a passing grade last year. Can this electronics retailer right itself in a rough environment for stores of its kind, or will hhgregg join Circuit City on the scrap heap of retailing history? Let's dig deeper to find out.

I'm far from the only Fool writer to point out the common ground hhgregg shares with Circuit City, and in some ways the comparison makes hhgregg look worse. Fool writer Brian Nichols notes that while Circuit City collapsed during the financial crisis, hhgregg suffered a 9.9% decline in comparable-store sales during the first quarter, a period recorded after years of economic recovery. It could be worse (but not by much), as rival RadioShack (NYSE: RSH  ) endured an abysmal 14% decline in comparable-store sales.

Both companies have posted far higher levels of operating expenses compared to their larger peer Best Buy (NYSE: BBY  ) , which Fool writer Timothy Green highlights as the leader of a moribund sector that's expected to endure a 2.6% sales decline in the second quarter. Best Buy's operating expense ratio of 20% during the first quarter was less than half RadioShack's, and a full third lower than hhgregg's, due to its aggressive cost-cutting moves. Expenses have hurt hhgregg badly, as you can see from the figures in our assessment above. And while hhgregg's free cash flow has held up well, its cash on hand has not -- the company's cash and short-term investments has rarely been above $50 million in any given quarter, and for several quarters over the past few years it fell dangerously close to zero. This game of bank-account chicken is not one that a company should be playing when forced to fight over fewer customers with less money to spend.

Longtime Fool consumer and tech specialist Rick Munarriz warned investors back in January to sell shares of the various big-box electronics retailers "while you still can," and that's certainly proven prescient -- Best Buy is the best performer of this trio with a 25% loss on the year, and even hhgregg's awful 2014 decline of 35% can't hold a candle to the two-thirds investors have lost in their RadioShack stock since the start of the year. Yet despite the obvious problems it faces at its existing stores, hhgregg has continued its expansion efforts with new stores opened in Ohio and Florida over the past month. The company might want to first improve its relationships with its own employees before attempting to build bridges to new consumers, as it was ranked the eighth-worst company to work for in America by 24/7 Wall St. last month, with a 36% approval rating for CEO Dennis May falling below even that of RadioShack CEO Joseph Magnacca, at 46%. With so much arrayed against it, and so little to look forward to, it seems that investors would be better off staying away from hhgregg until it can prove itself capable of navigating the rough waters of today's retail environment.

Putting the pieces together
Today, hhgregg has few 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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