Is Western Union Destined for Greatness?

Every investor can appreciate a stock that consistently beats the Street without getting ahead of its fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with improving financial metrics that support strong price growth. Let's take a look at what Western Union's (WU 1.35%) recent results tell us about its potential for future gains.

What the numbers tell you
The graphs you're about to see tell Western Union's story, and we'll be grading the quality of that story in several ways.

Growth is important on both top and bottom lines, and an improving profit margin is a great sign that a company's become more efficient over time. Since profits may not always reported at a steady rate, we'll also look at how much Western Union's free cash flow has grown in comparison to its net income.

A company that generates more earnings per share over time, regardless of the number of shares outstanding, is heading in the right direction. If Western Union's share price has kept pace with its earnings growth, that's another good sign that its stock can move higher.

Is Western Union managing its resources well? A company's return on equity should be improving, and its debt to equity ratio declining, if it's to earn our approval.

Healthy dividends are always welcome, so we'll also make sure that Western Union's dividend payouts are increasing, but at a level that can be sustained by its free cash flow.

By the numbers
Now, let's take a look at Western Union's key statistics:

WU Total Return Price data by YCharts.

Source: YCharts. *Period begins at end of Q3 2009.

WU Return on Equity data by YCharts.

Source: YCharts. *Period begins at end of Q3 2009.

How we got here, and where we're going
Six of nine passing grades is a pretty good score, and from the looks of it, Western Union's shareholders may have been overly punished in the past three years. Even though free cash flow is down, the stock has dropped harder. Is the big drop this year justified, or will patient shareholders be rewarded with a rebound in 2013?

The company's big drop came as a result of weak guidance, which comes in well below this year's trailing 12-month (including 2011's fourth quarter) diluted earnings per share . A reader's comment to that drop, asserting that mobile phones are making instantaneous low-cost (or no-cost) money transfers viable for millions in Western Union's target market, seems to hit on one important reason for the sell-off. Western Union's already lowering its prices to stay competitive, which isn't going to help unless significantly more transfers take place.

One thing in Western Union's favor is its vast network of transfer agents, and its superior transaction volume over smaller rival MoneyGram (MGI). In the long run, that may not matter if Western Union can't continue to present a superior option. In terms of consistent profitability, Western Union's credit card cousins -- which offer their own cash transfer options, though these are less publicized -- are not all that far ahead, and Western Union beats all but one in one important way:

Source: Wolfram Alpha and YCharts.

Free cash flow yield is simply a ratio of the company's cash flow per share to its stock price per share. On this measure, Western Union's doing far better than most, and it could support a higher dividend payout with ease. Western Union was also keeping pace with the credit card companies' bottom-line growth , with the exception of AmEx's impressive tripling of net income, over the past three years. Of course, all three of the credit card issuers have seen their free cash flows positively skyrocket  in the same three years that Western Union's declined 11%, highlighting the importance of looking at different angles.

Putting the pieces together
Today, Western Union 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.