Is Star Scientific 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 Star Scientific's (NASDAQ: STSI) recent results tell us about its potential for future gains.

What the numbers tell you
The graphs you're about to see tell Star'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 Star'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 Star's share price has kept pace with its earnings growth, that's another good sign that its stock can move higher.

Is Star 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.

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

STSI Total Return Price data by YCharts.

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

STSI Return on Equity data by YCharts.

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

How we got here and where we're going
Despite razor-thin revenues (under $6 million for the trailing 12 months), Star Scientific does appear to be heading in the right direction. Although it remains deeply unprofitable, free cash flow levels have not declined as precipitously as net income, and recent margin improvements indicate the possibility of genuine profitability in 2013. All told, Star racks up five of seven possible passing grades, many of which were earned due to the technical improvement from one negative number to a smaller negative result. Will this year be the one that Star shareholders finally see a P/E ratio in analyses of the company?

A year ago, we'd probably start by comparing Star Scientific to tobacco purveyors, as it was historically known for smokeless-tobacco alternatives. However, the company has exited that business  as of this year due to continually low sales. Despite the purported health benefits of the company's tobacco-alternative products, marketing restrictions made it difficult to properly present a comparison to the regular tobacco, whether smoked or otherwise, sold by Altria (MO -0.28%) and other major cigarette manufacturers. Star will retain its CigRx smoking-cessation supplement, but this product has not caught on well in a market dominated by GlaxoSmithKline's (GSK -3.84%) Nicorette  gum and NicoDerm  patches. So if the tobacco business isn't Star's future, what is?

Investors who checked into this stock's 15% pop early on Tuesday (it's since given back nearly all of those gains) know the answer -- Star is hoping to ride interest in Antabloc, an anti-inflammatory that was just shown to produce statistically significant reductions in antibody levels in a study reported this morning. Star is banking heavily on this product, and has now signed up tennis pro John Isner and golf champion Fred Couples to promote it to the public. As a relatively un-sporty person, I'd never heard of John Isner before, but Fred Couples could be the right person to appeal to an older and achier golf-loving demographic. Star's also partnered with GNC (GNC) to sell the supplement, which both broadens its sales potential and reduces its medical cachet -- GNC is known more for expensive fitness and weight-loss gimmicks than restorative cure-alls.

This year will be an important one for Star shareholders. It remains very narrowly focused, but that focus has now shifted significantly, from smoking alternatives to anti-inflammatories.

Putting the pieces together
Today, Star 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.